Gold assets such as bars, collectible coins, or jewelry derive from this scarce resource. However, the majority of the gold market's trade is indirect, via speculative assets that typically do not hold significant physical gold.
This indirect trading in the gold markets occurs primarily through the London and New York stock exchanges, futures contracts, options, and gold ETFs, traded on standard stock markets. There are substantial differences between these financial instruments tracking gold, some offering liquid, convenient investment options. However, it's crucial for every investor in this field to understand a key difference between these options and buying physical gold: investing in these financial instruments happens through brokers, placing the investor further from the ownership of the precious metal and exposing them to associated risks.
Physical Gold: A Stable and Movable Asset
The primary reason for gold's distinctive value is the scarcity of this shining metal, an advantage proven over millennia. To date, 190 thousand tons of gold have been mined worldwide, with an estimated 50 thousand tons still untouched underground. This scarcity sets gold apart from other precious metals and most other investment channels. With the constant demand for gold assets and the limited supply of the metal, price stability has been ensured and is expected to continue in the future.
Owning physical gold assets such as gold coins, bars, and medals offers investors a direct link to the rare metal and the opportunity for mobility and trading, anytime, anywhere. The majority of assets in the gold market, merely derivatives of the physical gold prices, do not offer these significant benefits.
The unlimited money printing by central banks during the COVID-19 crisis has intensified the attraction to gold. Economists at Goldman Sachs recently labeled gold as the "currency of last resort," particularly in the current environment where governments devalue their currencies and push interest rates to record lows.
Famed investor Warren Buffett, a long-time gold investment critic, has adjusted his stance given recent events. His investment company, Berkshire Hathaway, purchased shares of a gold mining company worth approximately half a billion dollars. Ray Dalio, founder of Bridgewater, one of the world's largest investment companies, categorically stated last year that "cash is trash, and too much money is still held in cash. An investment portfolio must include gold," referring mainly to physical gold.
The Drawbacks of ETFs and Gold Derivatives
Gold ETFs are a convenient and common investment tool. While they are meant to be tied to gold prices, not all, in reality, involve gold purchase. Many investors are unaware that gold ETFs often do not involve significant investments in physical gold. Also, ETFs investing a considerable portion of their assets in actual gold bars still pose two significant risks for an investor.
Third-Party Risk
A key motivation for investing in gold is its status as a secure, independent, and mobile asset. Investment in gold offers a "security certificate" against unforeseen economic and political events such as rampant inflation, financial crises, government bankruptcies, and more.
With gold derivatives, an investor relies on brokerage firms that face their own business challenges, regulatory changes, among other issues. Therefore, investing in gold derivatives like ETFs or options lacks the security of holding physical gold, which the investor genuinely owns.
Market Risk
Given that physical gold represents only 1% or less of the gold derivatives market, there is a potential, albeit low, risk of a crisis should any of the shareholders decide to liquidate their investments at a specific moment. Such demand would be impossible due to the limited amount of physical gold compared to the vast value of derivatives.
Past events have shown similar situations in the silver markets, where the U.S. government had to intervene aggressively to protect investors. The ones likely to be harmed by such market turmoil will likely be those who buy gold derivatives, while those holding physical gold will enjoy relative protection, possibly even experiencing a surge in the value of their metal as a result of such a crisis.