Beware Of Physical Gold's Diminishing Value

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  • How the hidden costs of holding physical bullion damages both long- and short-term performance results.
  • Why gold dealers win while gold investors and traders lose.
  • How physical bullion's constraints limit liquidity and trading flexibility.
  • Better alternatives to investing in physical bullion.

Gold has been dubbed by some as the "world's friend for 5,000 years". While that may be true to varying degrees, it doesn't necessarily mean gold or precious metals have been a friendly place to invest. A recent example of gold's unfriendly string is its 28-year period of long suffering. After gold prices peaked in nominal dollars at $850 per ounce in 1980, it wasn't until 2008 that gold was able to eventually match its 1980 peak price. To reinforce their own biases, goldbugs will typically reframe the results by attempting to inflation adjust gold prices to make the 1980-2008 blue period look more tolerable. But much has changed since 1980. Back then, investing in gold commodities futures contracts or buying physical bullion were the limited set of choices for obtaining gold exposure. Today, that's no longer the case.

The gold market was forever changed in 2004. That's when Wall Street securitized gold, by introducing a gold linked exchange-traded product or "ETP" named the SPDR Gold Shares Trust (NYSEARCA:GLD). The general idea behind GLD was to provide affordable gold exposure and daily liquidity without the hassle of taking physical delivery. The introduction of GLD in 2004 was a key turning point in the history of the gold marketplace. Not only did it usher in a new wave of other precious metals-linked products, but it provided the investing public and institutional investors alike with viable alternatives. Moreover, it also triggered a steep decline in the diminishing benefit of owning physical bullion - that to this very day has yet to subside. Let's examine key reasons why the value of owning physical gold has greatly diminished.

Lack of Liquidity

The subject of liquidity shouldn't be taken lightly. As we saw during the 2008-09 financial crisis, multi-billion dollar corporations went bust overnight due to a lack of liquidity. And if liquidity matters for large institutions, you better believe it matters for individuals. Simply put, liquidity deals with how quickly an asset can be converted to cash. The longer it takes to convert an asset to cash, the less liquid the asset is. The only way to convert physical gold - whether it's held as jewelry, coins, or in another physical form - is to sell it to a dealer or private party. And that can take time.

Let's suppose you locate a private party to buy your gold. If they don't live anywhere near you, it'll be your job to ship the gold to them. Not only will it cost you money in shipping and insurance fees, but it'll cost you time. You'll need to wait for your private party to receive and approve the gold shipment. Along the way, the entire process can take several weeks or even months, depending on how long it takes you to find a buyer and how soon you can complete the final transaction.

Better alternative: With gold ETPs, your gold is quickly converted into cash by simply executing a trade. For example, if I put $100,000 into the World Gold Shares SPDR Gold Minishares Trust (GLDM), I can convert my gold into cash and back whenever the stock market is open for business.The gold market trades 24/7, so not being able to trade a gold ETP outside of stock exchange hours is an obvious drawback. However, that drawback is minimized, because even with limited trading hours, a gold ETP's liquidity is still higher compared to owning physical bullion.

Bottom line: Gold ETPs have better liquidity compared to physical gold because they can be converted into cash equivalents more rapidly.

Gold Dollar Comparison

Elevated Trading Costs

Whenever physical gold owners buy and sell, it's the gold dealers that get rich. Here's a real-life case study in the cost of bid/ask spreads on physical gold.

I recently visited a gold dealer's website, and if you bought a one 1 oz. Canadian Gold Map Leaf coin, it would cost you around $1,259.71. If you sold the same coin, you would get only $1,213.72. The trading spread, or difference, is $45.99, which is an almost 4% spread between the bid price and the asking price. How does a 4% trading spread compare with a similar investment in gold ETPs?

The SPDR Gold Shares had a recent bid/ask spread of just 0.35%, which is almost 12 times less versus the bid/ask spreads for trading physical Canadian Gold Maple Leaf Coins.

Here's something else: You can buy and sell gold ETPs on many trading platforms for less than $10 per trade, and depending on the brokerage platform, you may incur zero brokerage fees because some firms now offer commission-free ETF trading! Remember: Bid/ask spreads are the differences between the price that you buy and sell your gold at. And the more you trade physical bullion, the more the bid/ask spreads will increase your trading costs and sharply reduce whatever profits you're able to secure.

Better alternative: Although gold ETPs, like physical bullion, do carry bid/ask spreads, they have lower overall trading costs.

Gold Sentiment

Insurance and Storage Fees

If you do a Google search and type the words "GOLD VAULT", you will see examples of how large institutions and central banks store their gold reserves. It's typically in the form of gold bars stacked carefully on top of each other.

To give you a general idea of how much money each of those gold bars is worth in today's money... it's approximately $500,000 for one standard "Good Delivery" gold bar. And that gold bar is a 400-troy ounce (or 438.9 ounces) hunk of metal. That's the standard gold reserve that's traded by central banks and bullion dealers.

If you're going to safely store that much gold, it requires a highly sophisticated security operation that cost lots of money to maintain. And if those systems fail, insurance policies will cover the losses. In all cases, the cost of security, storage, and insurance is an ongoing expense.

In the case of individual investors, these same costs - security, storage, and insurance - are real costs that reduce the net return of owning physical gold bullion. In contrast, when you buy a gold ETP, the fee you pay to the product sponsor pays for the cost of gold storage, insurance, and security. Let's look at an example.

Suppose you invested $100,000 in the iShares Gold Trust (IAU). The annual fee charged by the fund is just 0.25%, or $250 for a $100,000 investment. Now ask: Would the annual security, storage, and insurance cost for a $100,000 investment in physical gold be less than or more than $250? In most cases, the gold ETP will be the lower-cost way to invest in gold bullion.

Bottom line: The cost of storage, security, and insurance of physical gold makes it bad deal. Stick with gold ETPs!

Trading Flexibility

The final nail in the coffin that testifies to the diminishing benefit of owning physical gold is a lack of trading flexibility. This, by the way, is the same department where gold ETPs excel. How? Gold ETPs give shareholders the ability to hedge, leverage, and generate income on gold. For example, if I'm interested in magnifying my bullish exposure to gold but without borrowing money from a broker, I could opt for the ProShares Ultra Gold ETF (UGL), which aims for 200% daily leverage to gold. On the other hand, if I want to hedge a long position I hold in a gold ETP, I could purchase temporary insurance in the form of put options. If my gold ETP falls in value, those losses would be offset by corresponding gains in my gold put options, thus protecting my financial position. Finally, investors can monetize their gold by owning gold ETPs. For instance, if I want to generate income on my gold ETP, I can sell covered calls so long as the ETP has underlying trading options. In other words, I've converted my gold - an asset with zero yield and no earnings - into a potential cash cow! Since 2012, we've successfully done this with the Income Mix Portfolio at ETFguide Premium. Waiting for gold prices to go up isn't the only way to capitalize and profit!

Bottom line: Gold ETPs offer maximum trading flexibility. You can hedge, leverage, or generate income. In contrast, owning physical gold offers limited investing choices.

Something for Skeptics

Orthodox proponents of physical gold investing (usually gold dealers, anti-government types, and survivalists) often make the false claim that gold ETPs don't own the gold they claim to own. They may also erroneously claim that gold ETPs don't allow you the flexibility of converting your shares into physical bullion. Even for hardcore anti-ETP skeptics, there's a potential solution. The VanEck Merk Gold Trust (OUNZ), for example, provides investors with a convenient and cost-efficient way to buy and hold gold in an ETP wrapper, but with the option to take physical delivery of gold. How does it work? If you invested $100,000 in OUNZ and said to the sponsor, "I want to take delivery of my gold", the trust would be required to honor that request. OUNZ holds gold as allocated London Bars, and according to the prospectus, can deliver a combination of gold bars along with coins, in the exact denomination of your physical gold request or share conversion. Moreover, it provides you with this mighty convenience for just 0.40% annually.

Bottom line: Gold ETPs provide lots of trading flexibility. So much, in fact, that you can now convert your gold ETPs into physical gold deliveries!


Gold investors should weigh the psychological comfort of owning physical bullion with the economic benefits of that decision. And an honest assessment may lead them to the same conclusion as myself and many others: gold-backed ETPs, even with their own shortcomings, are still a superior alternative to owning physical gold.

This article was written by

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Ron DeLegge the Founder @ ETFguide. We offer premium ETF research, online classes, and FREE ETF Guides. Our investing philosophy is summed up in three words: BUILD, GROW, and PROTECT your money. Be sure to check out our weekly ETF videos at

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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