Physical Gold
Gold Buying Motives
Firstly, it is worth reviewing your motive for gaining exposure to gold – to hedge, to invest or to speculate. This can be done by identifying your primary goal, time horizon and attitude to risk, using the table below:
| Motive: | Hedge | Invest | Speculate |
|---|---|---|---|
| Goal | reduce risk with an offsetting position | grow wealth with assets based on fundamental value | fast profits from price swings |
| Horizon | short to long term | long term (years to decades) | short term (hours to months) |
| Risk | risk averse | moderate risk | risk seeking |
Gold Buying Options
Secondly, it is worth understanding which option for gaining exposure to gold best matches your motive. The 3 main options are physical gold, paper gold and gold mining shares.
Physical gold refers to gold that has been delivered to you or your storage operator. Gold bullion refers to physical gold manufactured in the form of coins, rounds or bars (with a high standardised purity).
Paper gold refers to a written agreement to receive the market value of gold in the future. Paper gold includes gold certificates issued by banks & mints, shares in exchange traded commodities (ETC’s) and options & futures contracts. With paper gold you don’t actually own gold, you own a written agreement with a third party. The third party selling paper gold owes you gold or the market value of gold. Paper gold agreements may contain clauses allowing settlement in cash instead of the market value of gold under certain conditions.
Gold mining shares are equities representing ownership in a company that explores for, extracts and refines gold.
These 3 options for gaining exposure to gold are mapped to the 3 different motives in the table below:
| Motive: | Hedge | Invest | Speculate |
|---|---|---|---|
| Physical Gold | Yes | Yes | No |
| Paper Gold | No | Yes | Yes |
| Gold Mining Shares | No | Yes | Yes |
As seen from the table above:
Physical gold can be used to hedge and to invest (if gold is undervalued).
Paper gold / gold mining shares can also be used to invest (& speculate), but not to hedge.
Physical Gold Benefits
While paper gold offers rapid liquidity, our comprehensive guide on how to buy gold is focused on physical gold because of the benefits explained below:
Physical gold has the following benefits compared to other investments:
no risk from inflation – unlike national currencies
no risk from bank failure – unlike bank accounts
no risk from closure of brokerage firms or stock exchanges – unlike shares
no risk from internet outage – unlike bitcoin
no capital gains tax (CGT) – unlike many assets, no VAT
no risk from your jurisdiction – unlike many assets
Physical gold’s benefits are relevant in times of uncertainty as explained below:
No risk from inflation
Printing money, euphemistically known as “quantitative easing”, increases the volume of money in circulation. The word “inflation” means price rises, but it used to mean an increase in the volume of money in circulation. Mining gold from the ground increases the volume of gold in circulation. The volume of money in circulation is increasing much faster than the volume of gold, because mining gold is much harder to do. Hence, the price of gold is rising and gold acts as insurance against “inflation”.
No risk from bank failure
When you pay money into a bank account, the ownership of your money is transferred from you to the bank. You are effectively making an un-secured loan to the bank, which can do whatever it wants with the money. This means that you may not receive the money back if the bank goes bust. A government backed insurance policy may cover some of the money, but in reality there is not enough money to pay back all the insured deposits in the banking system. It is recommended not to store gold in a bank for the same reason.
Physical gold can be stored in a vault without ownership being transferred to the owner of the vault. You can retain ownership of the gold irrespective of the solvency of the vault owner. So if the vault owner goes bust then you can still get your gold back. Risks such as theft and fraud still exist, but these can be mitigated with insurance.
No risk from closure of brokerage firms or stock exchanges
When you buy shares through brokerage firms, you are generally not the outright legal owner of the shares – you are just the beneficial owner.
This means that:
- your name does not appear in the shareholder register of the company that you have bought shares in – it will show the name of your brokerage firm
- ultimately your brokerage firm controls your shares
- your brokerage firm may be lending your shares to short-sellers or using them as collateral for its own obligations without your knowledge
- if the brokerage firm should become bankrupt then you may not recover 100% of your shares
It is possible to buy and store physical gold with a third party while retaining outright legal ownership of the gold, so that there is no counterparty risk arising from having only beneficial ownership. Risks such as theft and fraud still exist, but these can be mitigated with insurance.
Closing stock exchanges during extreme market conditions prevents the sale of shares. Physical gold does not have to be sold through a central exchange and hence does not carry this risk. Paper gold and gold mining shares are subject to this risk.
No risk from internet outage
Bitcoin transactions are generally dependent on verification by 6 third-parties via the internet.
Physical gold transactions can be dependent on only 2 individuals, without any third-parties or technology.
Paper gold and gold mining shares are subject to this risk.
No Capital Gains Tax (CGT), no VAT
Most assets (eg property, shares & bitcoin) are generally subject to CGT. However, it is possible to buy physical gold in ways that it is not subject to CGT. It is also possible to buy physical gold in ways that it is exempt from VAT. Paper gold and gold mining shares are subject to CGT.
No risk from your jurisdiction
Assets that are physically located in the same jurisdiction as you (eg property & land) are subject to the laws of your jurisdiction. If your government’s financial position is weak, then these assets could be at risk from confiscation. In 1933, the US government confiscated gold from its citizens. It is possible to store gold in a jurisdiction where the government’s financial position is not weak and hence confiscation is unlikely. Paper gold and gold mining shares are subject to this risk.