There are different ways to invest in gold: physical gold, gold ETFs and more generally paper gold. We will see what are the properties of gold ETFs in order to help you make the right choice.
Key takeaways
Gold ETFs, also known as paper gold, are one of the ways to invest in gold. It is important to consider the pros and cons of these assets before buying them.
While gold ETFs are convenient for short-term trading and can be easily converted into cash, they could carry counterparty risks.
When you buy gold ETFs you don’t really own gold. In reality, the institution that sold you an ETF share might only hold a fraction of your asset’s value in physical metal.
Table of contents
As a precious metals investor, you have probably come across the notion of gold ETFs, also known as paper gold.
As with any other investment, it has certain advantages and disadvantages: while some investors see it as an easier way to buy gold, others think it might be too risky and volatile.
To give you a better understanding of what gold ETFs are and how they work, on this page we explain:
What is a gold ETF: definition
the advantages of gold ETFs
the risks of gold ETFs
What is a gold ETF: definition
Gold ETF is the general term usually used to describe the different types of gold-related assets.
It is one of the 3 main types of paper gold:
gold ETF
gold future
gold certificate
Gold ETFs
ETFs (exchange-traded funds) are commodity funds that act like individual stocks and are traded through online brokers and broker-dealers.
Gold-backed ETFs allow investors to gain exposure to the gold price without having to purchase the physical metal.
If you decided to buy gold ETFs, it is important to know that only a few of these ETFs actually hold physical gold. In other words, if you decide to redeem a gold ETF, you will not get the physical product. Instead, you will be compensated in cash.
Gold futures
A gold future is a financial contract between an investor and a seller where an investor agrees to buy a specific amount of gold at a preset price and date.
Like with ETFs, buying a gold futures contract does not imply that you will get the physical asset immediately. Rather, futures contract gives an investor the right to purchase a precious metal at a later date.
Gold futures are usually traded on the Comex, a futures and options market for commodities like silver, gold, aluminum, and copper.
Gold certificate
Nowadays, gold certificates are less popular than ETFs and gold futures. While they are still issued by some banks and companies in the U.S., gold certificates mostly have a collectible value.
As with other types of paper gold, gold certificates allow you to own physical gold without actually taking possession the physical metal. In this case, a certificate proves that you own a certain amount of gold.
Now, since gold ETF are the most common type of paper gold, let's look at them in more detail.
What are the advantages of gold ETF investment?
Gold ETFs certainly have several advantages that make them look attractive as an investment. By and large, there are 3 key advantages of gold ETFs:
They can be converted into cash quite easily
They entail no shipping fees
They cannot be physically stolen
Gold ETFs can be easily converted into cash
You can exchange your gold ETFs into cash any time during market hours, which is quite convenient for short-term trading.
Moreover, you can invest practically any amount of money in gold-backed ETFs. The minimal investment is 1 unit, which is equivalent to 1 g of gold.
Gold ETFs don't have shipping fees
With ETFs, you will only have to pay a commission fee a broker will charge you for the transaction.
The same goes for storage — ETF assets don’t have extra storage costs because they’re purchased on a stock exchange.
Gold ETFs are impossible to physically steal
Unlike physical gold that has to be stored in a secure vault for safety, paper gold assets only exist in a digital form. This means that while paper gold investments may technically be impossible to physically steal, they are still vulnerable to server issues or hacking.
What are the risks of gold ETF investment?
Like any other asset, ETFs and other forms of paper gold come with several risks that precious metals investors should keep in mind, for example:
When you buy a form of paper gold, you don’t usually get to own the physical metal
All paper gold assets might carry counterparty risks
Paper gold can be subject to tracking errors
You don’t own physical gold
When you buy gold-backed assets, you don’t really own gold. In reality, the institution that sold you an ETF share might only hold a fraction of your asset’s value in physical metal.
For example, if too many investors want to cash in their gold-backed ETFs, the fund that sold it to them might not have enough of the physical metal to repay everyone.
Paper gold may carry counterparty risks
A company or a broker in charge of your ETFs or your gold certificate could go bankrupt or simply fail to live up to their obligations, misrepresenting the true state of their portfolio.
Counterparty risk can therefore cause you to loose some or all of your paper gold investment.
Paper gold may be subject to tracking errors and volatility
Tracking errors arise mainly due to transaction costs as well as the expenses charged for managing the fund.
Therefore, a slight degree of tracking error is somewhat natural in any ETF product; however, it may also lead to unexpected profits or, more often, unexpected losses.
Moreover, the gold futures market can be quite volatile, especially due to the speculative nature of gold futures assets.
This means that if gold ETFs offer a chance to win 2,000 U.S. dollars, euros, or Swiss francs more “easily”, they also risk seeing you lose those 2,000 U.S. dollars, euros, or Swiss francs just as fast.
Should I invest in gold ETF?
Ultimately, whether or not to buy any form of paper gold is largely determined by one's investment goals and strategy.
So if you're an experienced investor looking for a short-term gold exposure and willing to accept certain risks like higher volatility and counterparties, a gold ETF or a gold future could be a good option.
Physical gold, on the other hand, may be a better choice if you want to have a direct exposure to gold, and own a tangible asset which is fully allocated (owned entirely by you), and has historically proven to hold its value over time. When it comes to buying physical gold, it is also very important to wisely chose where to buy gold.
Alternatively, you may also benefit from the advantages of paper gold and physical gold by adding both assets to your investment portfolio: paper gold for short-term trading and physical gold for long-term saving.
