Physical Gold vs. Gold Funds: Which is More Efficient?

Investing in Gold: Physical Gold vs. Gold ETFs

For investors considering gold in light of its rise in recent years, the key question isn’t just whether to invest, but how. The choice between physical gold and gold-based securities like ETFs involves important trade-offs in liquidity, costs, security, and practical considerations.

In general, gold exchange-traded funds (ETFs) offer certain tax advantages, greater liquidity, and lower costs over time than trading physical gold. Below, we’ll guide you through your options for each, giving you a better sense of which, if either, works best for your portfolio.

The Recent Bull Run in Gold

In recent years, gold has been in a strong bull market, with prices reaching record highs above $2,700 per ounce in 2024. Several factors have driven this surge:

• Global economic uncertainty: Ongoing geopolitical tensions, inflation concerns, and global economic instability have increased gold’s appeal as a safe haven.
• Central bank policies: Anticipated interest rate cuts by major central banks, particularly the U.S. Federal Reserve, have made non-yielding assets like gold more attractive.
• Inflation: After recent bouts of high inflation, the cost of goods remains elevated. Gold is often viewed as a hedge against inflation, though prices have continued upward since inflation began dying down in 2023 and 2024.
• Increased demand: Central banks, particularly in emerging markets, have increased their gold reserves, contributing to higher demand.
• Currency devaluation concerns: Worries about the potential devaluation of fiat currencies have led investors to seek out gold as a store of value.
• Technical factors: Gold breaking through previous resistance levels has triggered further buying from momentum traders and algorithmic trading systems.

However, while the long-term outlook for gold remains positive, the market could face short-term corrections and volatility. Factors that could halt or reverse the bull market include a tightening of central bank monetary policy, a stronger U.S. dollar, a rapid resolution of major geopolitical conflicts, or a substantial increase in real interest rates.

That said, much of this has occurred while gold continues its upward trend. Its current price and recent trends are below:

Buying Physical Gold

Physical gold can be bought in several ways, and gold mines are found in more places than is typical for other commodities. The largest producers of gold are Australia, Canada, China, South Africa, and the U.S. Gold jewelry is sold worldwide in retail stores and the secondhand market. The quality or purity of the gold in such items is measured in karats (or 1/24th parts).

According to the U.S. Geological Survey, for the year 2023, gold jewelry accounted for about 43% of the market for the metal in the U.S. Physical bars or bullion made up about 16%, with another 9% going into gold coins.

How To Buy Physical Gold

Investing in physical gold involves purchasing actual gold in various forms such as coins, bars, or jewelry. Here’s an overview of the process:

1. Choose the form: Decide whether you want to buy gold coins, bars, or jewelry. Each has its advantages in terms of liquidity and premium over spot price.
2. Find a reputable dealer: Look for established dealers with good reputations. Private dealers, pawn broker, and like outlets for gold should be treated with a high degree of skepticism.
3. Verify authenticity: Ensure the gold you’re buying is genuine.
4. Compare prices: Gold prices can vary between dealers. Compare prices, including any premiums or mark-ups over the spot price of gold.
5. Consider storage and insurance: Plan for secure storage, either at home in a safe or in a bank safety deposit box. Also, consider insurance for your gold.
6. Keep your records: Maintain detailed records of your purchases, including receipts and certificates of authenticity.

While the price of gold has reached over $2,700 an ounce, the inflation-adjusted record remains the price set in January 1980, when it stood at around $3,300 (in 2024 dollars).

When buying physical gold, you’ll need somewhere safe to store it and get it insured. You’ll also want to ensure you’re getting what you pay for. This area of investing is notorious for scams involving gold mines that don’t exist, gold bars that are not all gold, and “digital certificates” that’s a modern version of fool’s gold.

The Commodities Futures Trading Commission, taking no chance at burying the lede in its summary, titles its memo on this commodity “Gold Is No Safe Investment.” Buy only from reputable dealers and have your gold appraised before buying. This adds to your costs, but it’s worth it for the peace of mind.

Buying Gold ETFs

Gold ETFs allow you to avoid all the complications of holding the physical metal while still having a change to gain from future price rises. Gold ETFs are typically structured as trusts that hold a certain number of gold bars for each share of the ETF issued. Buying a share of the ETF means owning a part of the gold held by the trust.

Because these ETFs hold physical gold, their share prices should track the price of gold over the short and long term. However, minor tracking errors sometimes occur when the ETF price deviates from its reference asset. When tracking errors occur, arbitrageurs quickly step in.

How To Invest in Gold ETFs

Investing in gold ETFs is far more straightforward than buying the commodity itself. Here’s a general guide:

1. Open a brokerage account: If you don’t already have one, open an account with a reputable online broker.
2. Research the different gold ETFs: Comparing their expense ratios, trading volume, and assets under management.
3. Place an order: Once you’ve chosen an ETF and have its ticker symbol, place an order through your brokerage platform. You can typically buy as little as one share, and many online brokers offer commission-free trading and fractional shares in ETFs.
4. Monitor your investment: Keep track of your ETF’s performance and keep abreast of changes in the sector.

There are many gold ETFs. We will consider two of the most popular choices:

SPDR Gold Shares (GLD)

The SPDR Gold Shares ETF (GLD) is one of the largest gold ETFs—it was also the first in 2024. As of late 2024, the fund held about 28.2 million ounces in its various vaults for a net asset value (NAV) of about $74.3 billion. Each share of the ETF was worth about 0.093 ounces of gold.

At the fund’s inception, shares were worth one-tenth the price of gold. The amount of gold represented by each share has eroded over time, as the ETF charges investors a 0.40% annual fee. These fees slowly lower the NAV of the ETF, thus slightly reducing the amount of gold that a share is worth each year.

This fee is relatively low given the costs of storing and insuring it yourself. According to the World Gold Council, gold returned an average of 8.30% per year between 1971 and 2024. Physical gold storage and insurance fees for small investors are usually higher than 0.4% per year. As such, gold ETFs are an efficient vehicle for investing in gold.

iShares Gold Trust (IAU)

Another popular choice for gold investors is the iShares Gold Trust (IAU) from BlackRock. Like SPDR Gold Shares, the iShares Gold Trust is organized as a trust, holding physical gold bars in vaults in London and New York.

As of late 2024, the ETF held over 12.1 million ounces for an NAV of $31.9 billion. With 640 million shares outstanding, each share represented about 0.019 ounces of gold. This can be eroded over time, as the fund has an expense ratio of 0.25%.

Leveraged and Inverse Gold ETNs

Leveraged and inverse gold funds are also available. These are more complex than ETFs because they do not physically hold the asset in trust. Instead, leveraged and inverse funds are usually traded as exchange-traded notes (ETNs), debt obligations of the ETN’s underwriter.

The price of an ETN tracks a commodity index. However, an ETN depends on the creditworthiness of the underwriter, and investors aren’t buying a stake in the gold that’s held.

Leveraged and inverse gold ETNs are intended only for short-term trades. They track gold’s daily moves, not the long-term changes. The use of leverage can magnify losses from volatility. Inverse gold funds have negative expected returns in the long run because gold prices generally rise in a fiat money system. Below are two of these ETNs.

ProShares Ultra Gold (UGL)

The ProShares Ultra Gold ETN (UGL) aims to provide twice the daily return of the Bloomberg Gold Subindex, a rolling index that tracks gold as measured by the price of COMEX gold futures contracts. The ETN’s leverage and daily reset feature make it suitable only for shorter-term traders. It has an expense ratio of 0.95%.

DB Gold Double Short ETN (DZZ)

The DB Gold Double Short ETN (DZZ) moves inversely to gold prices. If gold moves up 1% on the day, DZZ should drop by 2% because it moves twice as much in the opposite direction. The notes are thinly traded, and the expense ratio is 0.75%. Deutsche Bank launched the ETN in 2008. In 2016, it stopped issuing further notes. However, investors can still buy and sell shares on the secondary market. The suspension of new issuances can affect the ETN’s liquidity and potentially its price, as the supply of shares in the market is fixed and no longer adjusts in response to demand.

Key Differences Between Physical Gold and Gold Funds

The most notable difference between physical gold and gold funds is that with the former, you have possession of gold. With funds, you are investing in gold, but somebody else holds it on your behalf. This direct ownership lets you physically handle and securely store your gold, granting you complete control without concerns about tracking errors or the broader market’s fluctuations.

Investing in gold funds means your investment is in gold indirectly, with the physical asset held and managed by professionals on your behalf. This method of investing is typically more efficient for several reasons:

• Easy to trade: Buying and selling shares in gold funds can be done quickly online without the physical handling, storage, and security concerns.
• No storage worries: Like romance movies don’t show you how they live happily ever after, so, too, old stories about finding a treasure chest of gold don’t go into the detail of the logical hassles of securing and insuring the metal. Investors don’t need to secure storage or insure the physical gold when investing in these funds.
• Professional management: The investment is overseen by experts who manage the fund, making informed decisions on behalf of investors, which can be particularly beneficial for those less familiar with the gold market.
• Lower costs: While gold funds incur expense ratios, these fees are generally lower than the combined costs of buying, storing, and insuring physical gold, making it usually more cost-effective.

This approach simplifies investing in gold and can be more accessible for individuals looking to include gold in their investment portfolios without the complexities of handling physical gold.

The Bottom Line

There are differences between investing in physical gold and gold ETFs that go beyond one being physical metal and the other being tradable shares. Nevertheless, a major advantage of gold funds is their generally higher liquidity because they can be bought and sold instantly on the stock market during trading hours. In contrast, selling physical gold requires finding a buyer and may involve authentication processes, which can take longer.

Inverse and leveraged ETNs are more complex than gold ETFs. They track daily gold price changes by going in the opposite direction or magnifying price moves. Leveraged and inverse ETNs are not meant to track long-term gold price changes. While the expense ratio of ETFs can erode the amount of gold each share represents, they are often more cost-effective than buying and storing physical gold.