Advantages and Disadvantages of Investing in Gold Bullion vs. Gold Stocks vs. Gold ETFs

Most analysts agree that a well-balanced portfolio should allot a certain amount, somewhere between 5-15%, to gold, depending on your outlook for the economy in the near, mid, and long-term future. One decision you need to make is how to allocate this portion amongst the several options for owning gold. You can invest in the physical yellow metal, buy gold mining equities, or buy gold ETFs.

Let’s look at some of the basic strategies for each of these types of gold investing.

Investing in Physical Gold Bullion

Amazingly, there are several ways you can invest in physical gold. Most people imagine hoarding the physical coins and bars themselves, maybe burying these in your backyard, but you can invest in bullion through “pooled” accounts (a bit like mutual funds), and you can also invest in physical gold directly without ever needing to store it yourself.

Buying physical gold and storing it yourself.

This is the most tangible option and might give the most feeling of security. If the world’s banking system collapses, it’s nice to know you’ve got some gold coins at home (or in a safety deposit box). The downside to keeping it yourself is theft and liquidity. You need to have the gold delivered to your home, you need to store it privately, and it also means that if you ever decide you need that money in a hurry later on, it might take a few days to be able to sell your gold. Also, you might want to spend money to insure it.

Investing in pooled accounts.

You can buy gold through a dealer like Kitco or the Perth Mint, own your exact allotted amount, but the gold itself will be fungible. This means that there is no specific gold barwith your name on it. Rather, an audited amount of gold is sitting around in the dealer’s storage facilities and the gold you “own” is really a promise to pay you back that amount of money once you decide to sell it again. You can, of course, opt to take delivery of your gold, at which point you would become a physical buyer.

Buy physical gold directly, but don’t take storage.

A variation and “middle way” between the above two options, you can buy gold most directly through a dealer like GoldMoney, which is basically a gold bank. GoldMoney does not use pooled accounts – you will actually have a gold bar there with “your name” on it, so to speak. Their vaults are audited regularly and if you buy a half ounce they will physically add a half ounce to their vaults for you. The advantage here is that they pay for the storage and insurance. There is also a considerable degree of liquidity, since, as a bank of sorts, GoldMoney gold is instantly convertible back into one of four currencies. The downside to this option is that there is a monthly fee for holding your gold, and this small amount gets deducted from your total goldgrams balance. Theoretically, then, if you let your account sit long enough, the balance could go down to zero (this would take an extremely long time, depending on the price of gold).

Top Gold and Silver Dealers – Invest Directly In Bars and Coins

Thus, the advantages of having your own gold bullion (bars or coins) is obvious. The disadvantages are security and liquidity, as well as having to pay fees for insuring your investment in one way or another. From an investment worth point of view, this is the purest way to play the metal as a commodity. When gold commodities and futures go up, the market worth of your gold bullion goes up. Gold is one of the few commodities in which it is possible to invest so directly as this.

Investing in Gold Explorers, Gold Miners, and other Gold Stocks

If you don’t want to deal with storage, insurance, or paying monthly account fees, investing in gold equities can be a much easier option. You’ve already got your brokerage account set up, you just need to purchase the stocks. Some of these gold stocks pay dividends, too.

Advantages of Gold Stocks

Market diversification. Gold equities don’t necessarily move in lockstep with the commodity. For various market-related reasons, the stock of Barrick (TSX: ABX) or Agnico-Eagle Mines (TSX: AEM) might be over or under-valued in relation to what the metal itself is doing. This may be disappointing when bullion is rising to new highs, but it can also counteract the effects of weaker gold prices when it happens. During the Great Depression, gold stocks soared, even when physical gold became illegal to own privately.

Asset diversification. In addition, many gold producers, like BHP Billiton, also produce a signficant number of other precious and common metals, and this can provide some more cushion to the stock and hedge against gold prices. It also means, however, that the stock will be open to risks coming in from other directions related to those metals, too.

Liquidity. Stocks can be relatively easy to get in and out of. If you need to sell on the open market, it’s much easier than having to find and contact a local dealer.

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Top 20 List of the Largest Canadian Gold Stocks

Disadvantages to Owning Gold Stocks

Broad Market cycles. It’s hard to say which would be the more potential victim to gold speculation, bullion or the stocks. But gold equities will also get caught up in general market forces such as bull and bear cycles that may not affect gold prices themselves as much. Gold stocks might act differently because they are equities, yet intricately linked to commodities, which are the most volatile asset class. Take a look at Barrick’s recent and very unique situation.

Company Risk. Because you’re dealing with individual companies, you’ve got management risk. A change in management, or management decisions, a lawsuit, political risk, local currency risk and other factors can all affect the valuation of the company itself and hence, the value of your stock.

Investing in Gold ETFs – Best Way To Go?

Gold ETFs might seem like the perfect common ground between the above two options. But don’t forget that there are different kinds of gold ETFs. Some trade gold futures. Others, more recently, can hold the physical bullion itself. Most exotically, there are also leveraged gold ETFs. These are intended for very experienced investors. If you are new to investing, let alone investing in gold, please do not start with leveraged gold ETFs! They might be (or, I should say, seem) simple to understand, but so is a sharp 10″ chopping knife.

Advantages of Holding Gold Bullion ETFs.

Depending on the type of ETF, you get the benefit of either asset form listed above – your own metal, safe storage, and liquidity. You also don’t have to pay insurance or account fees. You might have more direct exposure to the commodity if your ETF, like GLD, holds the bullion itself in vaults. On the other hand, if you prefer owning the equities, and you want a dividend of some sort, then an equity ETF is the way to go and really does provide unique value – maximum diversification with a tiny bit of income, too.

Disadvantages of Holding Gold Bullion ETFs.

There are still fees that eat up your costs here – the ETF management fee, as well as commission fees for each buy and sell. There is the market risk of the underlying companies, and depending on how actively managed your ETF is — some are actively managed, yes — there may be some management risk or turnover risk. You must check out the specific ETF you are interested in and research its own exposures. I’ve provided a list of the common gold ETFs in a previous post.

My take: if you’re a beginner, or new to investing in gold, at this point I would probably recommend an ETF, although you will have to determine whether it would invest in a gold index (such as iShares XGD) or bullion itself (such as GLD). Because the gold companies can be so subject to cyclical forces as well as production forces, it makes sense to spread your risk out among a number of them. Once you become more familiar with the landscape and get to know individual companies you might want to consider investing in a particular company. I’ve made a list of the top 20 most-traded Canadian gold stocks as a resource. It also lists some of the more common gold ETFs.

Mutual funds are an option too, although they are less and less what I would recommend due to fees for management and other costs. If you can find a mutual fund with an MER comparable to its closest ETF, it might be worth considering.

Whichever asset group you choose, it’s smart to have at least some exposure to gold – it’s not just an investment, it’s a form of insurance, too. Like having an emergency fund, gold can help insulate your portfolio from market shocks like inflation, since gold is negatively correlated with various sector movements. Just be sure to do your due diligence before making your final decision.