How to Invest in Gold the Smart Way. Physical vs. Synthetic Gold Investments
We’d like to preface this article by mentioning the Money Exhibition Asia, which took place on 11–12 June this year at Centara Grand & Bangkok Convention Centre in Thailand.
Quantango’s CEO and co-founder, Vitalii Bulynin, was a speaker there as an experienced FX executive skilled in negotiation, trading, derivatives, stocks, and options.
Sharing the stage with other trading professionals at MoneyExpo was a delight and an extremely valuable opportunity, both idea and networking-wise. Tremendous gratitude to the organizers for their efforts to connect so many great experts.
Now, let’s move on to the topic of today’s article — gold, or more precisely, investments in gold. Physical versus synthetic, and the advantages and disadvantages of each.
The Golden Era of Trading
Investing in gold has always been popular. Remember the gold rush? It’s safe to say that, in a way, it never ended. And in recent years, the popularity of gold investments has risen again.
Investors, from beginners to pros, are now flocking to gold to protect their money. One reason is COVID-19 and its disruptive nature in pretty much all fields.
The global pandemic has really highlighted gold’s value as a safe-haven asset that can hold its value even during rough times and even hedge you from possible fiscal and monetary changes.
And let’s be honest — gold is something we all understand and feel comfortable with.
There are many ways to invest in gold, from physical gold bars and coins to equities, mining stocks, and synthetic derivatives. We’ll call the last one simply synthetics from now on.
Popular Gold Investment Instruments
At the moment, there are three most popular gold investment instruments:
1. Exchange-traded products (ETPs) based on physical gold;
2. Gold futures as broad-class derivatives;
3. Gold-based CFDs (Contracts for Difference), namely XAU/USD.
If it’s based on the same product, you might ask, why is it so complicated? However, each instrument has rather important differences in price discovery, liquidity, leverage, cost structure, and counterparty risk that you have to consider.
Let’s start with physical gold exchange-traded products or ETPs.
ETPs
This is gold as we know it. The tangible kind. If you’re still thinking about the gold rush we mentioned earlier and the scale of it, let the numbers speak for themselves.
The amount of gold held on behalf of physically backed gold exchange-traded products (ETPs) has grown to over 3,000 tons, with total assets under management exceeding $235 billion.
These gold ETPs came to market in the early 2000s, completely changing the way investors could access the precious metals market. By purchasing ETP shares, investors gain exposure to the underlying physical gold, which is then securely stored in vaults on their behalf.
The great thing about gold ETPs is that they offer the liquidity and tradability of stocks with the attractive store-of-value of physical gold, which is the base of gold’s recent success in general.
How Does an ETP Work?
Think of them as units that you buy like stocks, backed by physical gold stored (somewhere in London) in custodian vaults. Each ETP gives a plain vanilla exposure to the price of gold, so when gold prices rise, so do ETP shares.
These instruments are highly liquid with tight bid-ask spreads. The pricing is closely tied to the LBMA (London Bullion Market Association) Gold Price, which is set twice daily through an electronic auction process involving 15 accredited financial institutions. This ensures a high degree of transparency and price discovery for investors.
The downside is that they come with relatively high transaction costs. For example, the world’s largest physical gold ETP, SPDR Gold Trust, has an annual expense ratio of 0.65%, meaning that your assets will be charged 0.65% of their value annually as a fee.
Another drawback is the lack of leverage because the investments are typically fully funded. Also, most ETPs don’t allocate specific gold bars to individual investors, making it quite challenging to take physical delivery of the gold.
Gold-Based Derivatives
What if we told you that you don’t really need physical gold delivery per se?
You only need exposure to trade its price. That’s where synthetics come into play.
Often called synthetic gold exposure, gold-based derivatives like futures contracts, swaps, options, and forwards follow the price of gold.
These are essentially bets on the future price of gold without ever owning the physical metal.
The main difference is the price discovery mechanism, which is determined by consensus among market participants rather than simply tracking the LBMA price. Futures are also quite sensitive to market conditions and expectations of the, you guessed it, future.
Advantages:
- Lower costs compared to ETPs;
- Little counterparty risk since they’re traded on regulated exchanges;
- The ability to use leverage, making it more capital-efficient.
Downside:
Trading with futures requires an understanding of commodity markets, including margin requirements, rollovers, and expiration events.
Gold CFDs
The third option is Contracts for Difference. CFDs are ideal if you want to gain gold exposure without the complexities of ETPs or futures because they combine the best of both worlds — the LBMA-based pricing of ETPs and the leveraged nature of futures contracts.
Spoiler alert — out of the investment options right now, CFDs would be our pick. Here’s why:
- Ease of trading and accessibility for retail investors
- Quick reaction times to market trends
- Ability to go long or short with ease
- High liquidity and low fees
- Significant leverage options
The downside is the counterparty risk, meaning your broker could potentially ditch their obligations to you. Don’t worry, you can help it. Remember to:
- Check reviews and listen to other traders’ experiences
- Conduct due diligence on your broker
- Understand your broker’s reputation and regulatory status, a.k.a. Know Your Broker (KYB)
Here’s our favorite part:
The ease of getting started with CFDs is exceptional. Download a platform, open an account, get verified, and start trading right away. You can make your deposits using cards, bank transfers, cryptocurrencies, and even QR codes.
Final Tip
Whether you choose physical gold, derivatives, or CFDs, don’t forget to do your research and match your investments with your goals and risk tolerance.
In this “golden era” of gold investing, there’s really no shortage of ways to get in. You know now how easy it is to buy, sell, and withdraw within minutes.
With just a little know-how, you can find the right fit for your portfolio and potentially strike gold (pun intended).
