Gold investment: differences between physical gold and “paper gold”

Gold investment for diversification 紙黃金

Decades ago when the stock market and retail investment products were not as easily accessible as now, our parents or grandparents often viewed gold investment as a safe haven to hold value and a hedge against inflation. This is also part of the reason why China’s “damas” are so obsessed with buying gold whenever they travel to the city.

Apart from being worn by brides as necklaces and bracelets at Chinese wedding banquets, gold investment always forms part of a diversification strategy because it has historically had a negative correlation to stocks and other instruments. A properly diversified portfolio combines gold with stocks, bonds, currencies, and sometimes property, which can reduce overall volatility and risk.

Buying and selling physical gold is not difficult, especially in Hong Kong where jewellery shops outnumber bakery shops in some districts. In terms of liquidity, the gold market is highly liquid. In addition to buying physical gold such as gold coins and bars, there are alternative ways for investors to gain exposure to the gold market referred to as paper gold.

What is paper gold investment?

So what’s the difference between “paper gold” and physical gold? And what are the pros and cons of investing in either? We will take ETF as an example of paper gold investment to demonstrate their differences.

ETFs track the price of real gold, minus the cost of managing the fund. In theory, the shareholder of a gold ETF has the rights to convert the “shares” into gold. But, in reality, investors are often discouraged from doing so by the ETF issuer. CEFs are backed by real gold owned by the company that issues the shares, but their fees are higher than ETFs.

Compared with buying and storing real gold that involves physical storage and insurance costs, paper gold has better liquidity and accessibility as they could be traded easily via most securities brokerage houses, especially if the investor wishes to capture short-term price movements.

The cost of buying paper gold can also be cheaper than that of physical gold. When buying physical gold, the investor has to pay a premium above the spot price, which includes the cost of refining the metal to its current form, plus a profit margin charged by the vendor, such as the jewellery shop.

By comparison, paper gold incurs no premium above the spot price but investors have to pay a commission to the brokerage house similar to buying company shares or ETFs. With a gold investment ETF, and all other ETFs, investors will also pay a small management fee.

Typical gold ETFs on the market are ETFs designed to track gold price movements, such as the London Gold Fixing Price. RMB gold ETFs are simply gold ETFs denominated in the Chinese currency, but investors will be subject to the foreign exchange risk when they realise their investment and convert the RMB proceeds into other currencies, such as HKD.

Alternative ways to enter gold investment market

There are also other more indirect ways of gaining exposure to the gold investment market, such as investing in gold mining companies, gold mutual funds or gold-linked deposits.

Gold mutual funds primarily have their assets allocated to precious metal bullion and the securities of companies involved with mining or dealing in gold or other precious metals. As with other mutual funds, gold mutual funds are managed by a fund manager and might require the investor to pay a sales load, ongoing management fees and redemption fees when selling or redeeming shares.

Gold-linked deposit is a fixed-rate term deposit linked to gold price movements, yielding relatively higher interest rates compared with plain-vanilla deposits.

Ultimately, whichever investment strategy you prefer when including gold into your portfolio, you should always read the product’s prospectus to take the product features into consideration, review the investment objectives and see if the risk factors are compatible with your risk tolerance level.

Important legal Notice

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