In the modern world, investors have plenty of options when it comes to commodity exposure. For gold investors specifically, the most common (and most frequently debated) choice is between investing in physical gold bullion — the bars and coins — or investing in gold mining stocks and exchange-traded funds (ETFs).
Except this is not really a choice at all. If you want the benefits of owning gold, your only real choice is physical bullion. Owning shares of gold is not the same as owning physical gold.
Note that this does not mean that owning gold stock or shares of a gold ETF are, per se, bad decisions. There may be many portfolios or investors who, based on their investment goals and available capital, are better served with equity exposure to gold. Alternatively, there may be many investors who are best served by owning physical gold bullion in their IRA and owning shares of gold mining companies.
At all times, American Bullion strives to provide honest and direct information to those interested in gold and gold investment strategies. Please interpret the following information within the context of your own personal financial goals. We are happy to answer any questions you have.
Characteristics of Gold Stocks and Gold ETFs
Traditional gold stocks are not investments in gold. Rather, a gold stock is an ownership equity share in a gold mining or refining company (just like an investment in Microsoft stock is a very small equity claim on Microsoft).
Because gold stocks are an equity claim in a publicly traded company, their value only tangentially depends on the value of gold. The real drivers of gold stock value are the fundamentals of the underlying company, including:
- How well is the company managed?
- What are the regulations surrounding gold mining / refining in the company’s mining regions?
- Has the company issued or redeemed shares recently?
- How is the overall stock market performing?
- Are there labor disputes or political unrest that impact the cash flow of the business?
Just as the stock price of McDonald’s is only loosely tied to the market price of potatoes or beef, the stock price of gold mining companies is loosely tied to the spot price of gold.
For decades, however, gold mining stocks were the only legal way for equity investors to buy gold-related products without owning physical bullion.
Then, in 2004, the Chicago-based investment management company State Street Global Advisors (SSGA) launched the SPDR Gold Shares ETF, also known by its ticker symbol GLD. This was a revolution in ETF structure; rather than investing in the shares of companies backed by revenue, GLD backed each share with one-tenth of an ounce of gold bullion. (Over time, this value eroded due to the fund’s operating expenses.)
Even though GLD created an equity instrument with a stronger commodity backing than the U.S. dollar, investors in this ETF still don’t actually own the physical gold. Instead, they owe equity claims on the underlying trust, which only seeks to replicate the price of gold.
This is critical to understand — there is a lot of confused marketing about GLD (and other copycat ETFs).
Yes, GLD is technically backed by gold. However, this does not mean that GLD acts like U.S. currency did back in the gold standard era. This is because investors in GLD do not have the ability to redeem their shares for bullion, which may be the whole point of a gold regime. Only authorized broker-dealers or other giant Wall Street institutions can create or redeem ETF shares.
Instead, GLD shareholders only own shares of a trust operated by HSBC. This bank is very secretive regarding its actual gold holdings, and there have already been questions about how much gold is actually held in the trust’s vault.
Advantages of Gold Stocks and ETFs
There are some bonuses to owning equities (whether in gold mining companies or any other publicly traded business). For example, the government does not require that shareholders store their shares in protected vaults or purchase insurance on them. (Then again, the lack of necessary protection might be indicative of the intrinsic value and tangibility of gold shares.)
Other potential advantages include:
- As a short-term investment, gold shares may appreciate in value faster than the spot price of gold.
- Gold mining companies may distribute dividends to shareholders.
- Stocks tend to be easier to liquidate than physical gold bullion (although this is less true in the modern internet age, and liquidation can still come with tax penalties inside of an IRA).
- Takes very little time to set up an account and buy exposure to gold.
Disadvantages of Gold Stocks and ETFs
No matter how well-designed an equity investment in gold may be, it cannot replicate the real thing. Until gold shares are redeemable in physical gold bars or coins, they remain a paper asset and their value can be reduced to zero even if the value of gold remains high.
Some other disadvantages include:
- Gold stocks and gold ETFs — even GLD — carry counterparty risk.
- Because any physical gold is held in a trust and not accessible by ordinary investors, gold shares do you no good in the event of a currency crisis or other geopolitical crisis.
- You pay a management fee to participate in equity investments (fund managers do not work for free).
- Shares do not carry the same barter ability as real, physical gold.
- Historically, the value of a gold share is much more volatile than the spot price of the actual metal.