July 15

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Physical Gold vs Paper Gold: Which Should You Buy?

Ilir Salihi

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Gold has been a reliable store of wealth since the dawn of civilization. Its beauty and scarcity have been valued by peoples worldwide, dating back to thousands of years B.C. Since then, entire civilizations have risen and fallen. Various forms of fiat currency have come into everyday use – and have then become worthless, except to artifacts collectors.

But gold, in any form, has by and large retained its value through the ages.

Yes, it comes in and out of favor. Its market price tends to rise compared to local currencies during times of economic uncertainty and chaos. But unlike paper representations of wealth, the value of gold has never fallen to zero – or anywhere near it.

So what are the options for owning gold? We'll look at physical gold vs "paper" gold and discuss the pros and cons of each.  Let's get started!

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Physical Vs Paper Gold

Gold has proven to be a valuable hedge against uncertainty, including the periodic debasement of currency that leads to inflation and hyperinflation.

Most people immediately grasp the ownership of physical gold. It takes multiple forms:

  • Direct ownership and possession of gold bullion coins, bars, and rounds
  • Ownership of gold in the form of collectibles like jewelry, art, and décor

Physical Gold You Can Hold

These forms of ownership have benefits beyond just investing. Many people who own physical gold derive great satisfaction from viewing and handling gold. Gold jewelry and coins are very beautiful. People enjoy feeling the “heft” of gold coins, bars, and jewelry in their hands. And in some cases, gold artifacts, coins, and other forms represent a part of history.

So owning physical gold has appeal not just to investors, but also to collectors and some historians.

But there are many other ways to own gold besides physical possession. These include:

Ownership of Gold Stored by a Third-Party Custodian

People who own gold in IRA accounts must use this method, since the law prohibits taxpayers from taking direct possession of gold held within retirement accounts.

Related: Home Storage Gold IRA - Scam or IRS-Approved?

Gold Certificates

This is the most basic form of gold ownership in basic form. A gold certificate is simply a piece of paper documenting ownership of a quantity of gold owned and stored by the issuing company.  Prior to 1933, when the U.S. abandoned the gold standard that underscored the value of the dollar, the U.S. Mint issued gold certificates, with face values equal to their dollar denominations, representing claims on gold held by the U.S. Treasury. These certificates were legal tender, just like dollar bills. However, in 1934, these certificates were replaced by dollars – which have lost more than 80% of their value since then.

No wonder the government wanted to drop certificates.

Some banks and other companies still issue certificates as proof of ownership of a given amount of bullion. In theory, owners can exchange these certificates with the issuer for a given amount of gold bullion, which is how these certificates retain their value.

Gold-Backed ETFs

ETFs, or “exchange-traded funds,” are index mutual funds whose shares are publicly traded on stock exchanges. These are very efficient and convenient investment vehicles, generally with low expenses. However, when you buy shares of an ETF or any other fund, you don’t have ownership of the gold itself. You have ownership of shares in the fund. The fund directly owns the gold. You don't. Exception: Some gold ETFs, such as the Van Eck Merck Gold Trust (OUNZ), will actually deliver physical gold on request.

These ETFs can be unleveraged or leveraged. Leveraged gold ETF funds borrow money to buy more gold – potentially increasing returns, but also increasing risk.

Gold Mutual Funds

These are simply mutual funds that buy gold and/or gold certificates, and issue shares in the fund to investors. As with gold-backed ETFs, you don’t own the gold, or even the certificates. You own shares in the fund.

Related: Augusta Precious Metals Review - Inside Look at the Gold IRA Company's Ratings, Complaints, Reviews, and More

Gold Mining Stocks

These are simply shares of companies that own and/or operate gold mining operations. When gold does well, their shares typically rise. They may also rise if the market learns they have had success in finding a vein of gold in one of their mines.

Unlike physical gold, gold mining stocks may pay a dividend when operations are profitable, or their cash on hand allows it. However, also unlike physical gold, gold mining companies can go bankrupt, and their shares can become worthless.

In recent years, another form of gold ownership has emerged in the form of cryptocurrency. Examples of gold-backed cryptocurrencies include the AABB Gold Token (AABBG), Tether Gold (XAUt),  and the Perth Mint Gold Token (PMGT).

Each form of gold ownership has advantages and disadvantages.

Let’s start with physical possession of gold bullion, which consists of gold coins, bars, and rounds manufactured specifically as a unit of storage and measurement of a specific weight of gold.

Related: Safeguard Your 401(k) or IRA with this Little-Known IRS Loophole

Retirement guide

Protect Your Wealth with Physical Gold & Silver

Get the Free 2021 Gold IRA Investor Kit Today. Includes: Printed Report, Audio Guide, and Video Presentation...


Physical Gold Advantages  

  • Tangibility. You can hold gold in your hand. Its value is obvious. Someone may doubt the authenticity of a gold certificate. Society can lose faith in any paper fiat currency – and nations have done so on many occasions. But anyone can examine a gold coin and verify its worth.
  • Portability. If you need to quietly and discreetly carry a large amount of money, it's easy to carry thousands of dollars of gold in a small handbag. This advantage of gold has been a lifesaver for many people forced to flee government or mob tyranny. Wealth in the form of real estate can be easily seized, and cannot be brought out of the country with you. But gold coins can.
  • Counterparties. When you have physical gold in your possession, it’s yours. You don’t have to worry about a third-party company getting embezzled, or having your gold stolen from its vault. You don’t have to worry about clerical errors in crediting your account, or fraudsters impersonating you and withdrawing your gold from their storage facility. You aren’t vulnerable to another company getting seized or driven into bankruptcy.

Physical Gold vs Paper Gold - which should you buy?

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Physical Gold Disadvantages

There are several disadvantages to holding and storing physical gold, as well:

  • Shipping costs. It costs money to insure and ship small quantities of gold to individual buyers. These costs show up directly on the invoice, or indirectly, hidden in the dealers’ price. But it’s always there, one way or the other.
  • Premiums. Gold dealers charge substantial premiums over and above the market spot price for gold. Usually, the smaller the gold purchase, the larger the premium as a percentage of the total cost. You can re-sell the gold at a profit. Or at least get some of your investment in gold back. But you can’t re-sell the premium you paid to the dealer, or the shipping costs. These costs come directly out of investment returns.
  • Risk of theft/loss. It’s always risky to hold gold or other precious metals in your home. It’s vulnerable to theft by burglars or even by members of your own household. You can mitigate the threat by adding the gold to your homeowner’s insurance policy. But this has a cost, as well.
  • You can reduce the threat by holding the gold in a safe deposit box or using a vault service. But these options also cost money. The cost of carry adds up over time. And gold doesn’t pay a dividend that helps you directly cover your storage and insurance costs. You must come up with the cash to pay those fees yourself.
  • Liquidity. While gold is convertible to cash much more readily than, say, a vacant lot you own on the edge of town, you can’t just head to the supermarket and buy a cart of groceries with gold coins. Depending on your location, it might be difficult or inconvenient to find a dealer willing to pay you a reasonable market price for your gold. With paper assets, you can usually have the investment company wire the cash to your account and debit your gold holdings accordingly. This can happen within a day. With gold coins, bars, and other forms of physical gold, you will need to make more of an effort.

Related: How to Diversify Your Retirement with Physical Precious Metals Like Gold & Silver

Advantages of Paper Forms of Gold Ownership

Owning gold via one of the several paper forms of ownership also has some advantages:

  • Liquidity. As we mentioned, you can usually have a gold investment company wire you cash for the value of your gold holdings quickly and easily. However, this is only true while the power grids and computer networks are working. In the event of a major disaster, an electromagnetic pulse, a terrorist or criminal attack or cyberattack on the financial institution, or a nuclear strike on a financial center housing the gold company's servers, all bets are off.
  • Efficiency. Buying and selling paper forms of gold is highly cost-efficient, especially on smaller amounts of gold. There are no shipping costs to worry about. Just broker commissions, which you would still usually pay if you bought from a gold broker. Commissions on paper gold products are generally lower than what you would pay to prominent gold brokers who buy and sell physical gold.
  • Leverage. Investment companies can cheaply and efficiently borrow money against their portfolio holdings and invest them – usually by buying more gold. This magnifies profits in rising markets. But it also magnifies risk. That said, risk-tolerant investors often like gold funds and ETFs that use leverage because it makes it possible to have the desired portfolio allocation to gold with a lower cash investment. This leverage therefore helps them preserve cash for other purposes.

Disadvantages of Paper Gold Ownership

The disadvantages of paper gold ownership include the following:

  • Counterparty risk. You are exposed to counterparty risk. Your gold storage or investment company could go bankrupt, get seized by local officials or bank regulators, engage in fraud, be a fraud or embezzlement victim itself, or become the victim of a cyberattack such as a ransomware attack that could impact your ability to access your wealth.
  • Legislative/Regulatory/Government risk. Investment companies that own gold on behalf of investors are obvious and convenient targets for governments looking to confiscate large amounts of wealth. This risk is low in the United States, but not unprecedented.

    The United States government forcibly confiscated all gold coins and bullion owned by ordinary citizens in 1933, when President Franklin D. Roosevelt signed Executive Order 6102. This forced Americans to sell their gold at deep discounts to market prices. Americans who failed to turn over all but $100 in gold coins to the government faced a $10,000 fine and up to ten years in prison.

The order also applied to gold certificates. In several SCOTUS cases following Executive Order 6102, a series of plaintiffs who had had their gold holdings seized and were compensated with the much lower face value of their gold holdings in cash sued, claiming they were entitled not just to the face value but to the market value of the gold holdings the Roosevelt Administration seized from their financial institutions.

Retirement guide

Protect Your Wealth with Physical Gold & Silver

Get the Free 2021 Gold IRA Investor Kit Today. Includes: Printed Report, Audio Guide, and Video Presentation...


The Supreme Court ruled 5-4 that the Federal Government had a plenary right to confiscate gold, and the defendants had no right to claim the value of the gold as opposed to the nominal face value of the gold coins and certificates.

Related: Diversify Your 401(k) or Investment Portfolio with Physical Silver Bullion

Conclusion

So which is preferable: Owning physical gold, or owning paper gold assets? 

The answer depends on your situation and your assessment of the risk. It also depends a great deal on your faith and confidence in the ongoing stability of the financial system.

If you think there’s a real risk of general societal collapse that will take down financial institutions and the general rule of law, you might want to lean towards physical possession: The government can’t confiscate gold they don’t know about.

On the other hand, if you are confident in the major institutions in your country, and are just trying to build a balanced portfolio using asset allocation, while keeping fees and bid-ask spreads to a minimum, you might consider one or more paper options.

If you are a speculator, then you might be attracted to the potential upside of owning one or more gold mining stocks – even with the potential risks of owning any single company’s stock.

And for many, a balanced approach may be best, combining both physical and paper forms of gold in your portfolio.

Protect Your Wealth with Physical Gold & Silver

Retirement guide

Get the Free 2021 Gold IRA Investor Kit Today. Includes: Printed Report, Audio Guide, and Video Presentation...

About the Author

Ilir writes about personal finance, entrepreneurship, and digital marketing. When he's not creating content online, he's spending time with his family in Washington, DC.

Ilir Salihi


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