Paper Gold vs Physical Gold – What Should You Buy in 2020?

Buying the right type of gold is key. You have the choice between physical gold vs paper gold in its many varied forms.

But how do you decide which type of gold is right for you? Is it paper gold or physical gold?

When deciding between paper and physical gold, the answer comes down to the main reason you are buying gold…

Are you only speculating on the price of gold or silver going up? Or are you buying gold or silver with a view to wealth protection? That is, as a form of financial insurance. Where you are protecting your wealth from the likes of the following:

  1. Inflation and Loss of Purchasing Power.
  2. Non Correlated Asset – smooth out your returns when shares/stocks, bonds and property are performing poorly.
  3. Diversification / Hedging in Times of Economic and Political Crises.

Learn more about gold as financial insurance and the protection it can offer. If wealth protection and insurance is your aim, then physical gold should be your choice over paper gold. Read on to see why…

What is Paper Gold?

Paper gold is a derivative of physical gold itself. Meaning the product is derived from and linked in some way to physical gold bullion, but not actually gold bullion itself.

Paper Gold vs Physical Gold - What To Buy?
Paper gold is often not gold at all – not even gold coloured paper!

Paper gold can include any of the following:

  • Unallocated or pooled gold accounts
  • Gold mining shares
  • Exchange Traded Fund’s (ETF’s)
  • Gold futures
  • Gold options
  • Contracts for Difference (CFD’s)

In the world of precious metals prices and amid talk of price manipulation, you’ll often hear the term “paper gold” mentioned. Such as “paper gold sets the price of gold”. In these cases the paper gold to which the writer is referring to is the gold futures market.

For more on this topic see: “Paper Gold” and Its Effect on the Gold Price

Along with: Flash Crash in Silver & a Tale of Two Gold Markets

What is the One Disadvantage All Paper Gold Has Compared to Physical Gold?

As per our definition earlier, all paper gold is a derivative of gold itself. Therefore all paper gold has what is called counter-party risk. Counter-party risk simply means your asset (in this case paper gold), is at the same time, someone else’s liability.

In the current global environment, the ongoing impacts of COVID-19 shut downs mean counter-party risk is likely a bigger concern than ever before. There is the potential for many businesses to come under financial pressure in the coming months and years.

So do you want to rely upon another party to remain solvent in order for your investment to maintain its value? Learn more about counterparty risk.

If you are buying gold as financial insurance, do you then want to keep track of the financial integrity of the company who manages your gold?

Different Types of Paper Gold:

Different types of paper gold also each have their own unique disadvantages. Let’s look at what they are:

Unallocated Gold vs Physical Gold

What is Unallocated Gold?

Unallocated gold or a pooled gold account, refers to gold from individual investors that is “pooled” together and stored and held by another party. Often a gold refiner, mint or sometimes a bank. Unallocated gold means investors gold are all pooled together.

Should you wish to withdraw your gold you will usually have to allow time for this to be done. When held by a refiner or mint this gold is often used as their working supply. So they fabricate gold from this supply and continuously replenish it. As a result you may not have to pay for storage.

Disadvantages of Unallocated Gold

  • You rely upon the honesty of the holder of the gold that they have bought and hold enough gold to cover all investors.
  • There is usually a delay should you wish to take delivery of your gold.

Gold ETF’s versus Gold Physical

What is a Gold ETF?

A Gold ETF is an Exchange Traded Fund which you can buy or sell via a stock or share market. It tracks the price of gold or a gold index. It may be backed by physical gold or merely track the price of gold using the likes of gold futures.

Disadvantages of Gold ETFs

  • You rely upon the fund manager to remain solvent. And you may also rely upon the custodian of the gold if it is a gold backed ETF.
  • If the ETF is not gold backed but merely a tracker then you are only tracking the gold price.
  • There may be not so obvious management fees each year.

Gold Shares vs Physical Gold

What are Gold Shares or Gold Stocks?

paper gold: Gold mining stock certificate
Paper gold includes gold mining shares or stocks. These days you don’t generally even get a certificate when buying gold stocks.

Gold shares or gold stocks are shares in the ownership of a gold mining or gold exploration company. You own a portion of the companies assets and liabilities. You may receive a dividend each year.

The price of gold stocks and shares will be impacted by the spot price of gold.  But the gold stock prices will also fluctuate due to many other business and market conditions.

Disadvantages of Gold Mining Stocks or Shares

You are investing in a business as opposed to owning financial insurance. Thereby associated risks include:

  • Management risk – who runs the company will have a large bearing on its profitability.
  • Geo-political risk – who is in government may impact the company. Gold mines have a history of being nationalised in some countries.
  • Lack of cashflow risk – Non producers are even more risky and speculative. Because they have no cash flow and trade instead based upon the level of gold reserves they have discovered.
  • Risk of dilution of ownership via issuing more shares – this is a common way a company can raise more capital for expansion or exploration. But it does mean you end up owning less of the business.
  • Further counterparty risk – Most shares are owned via a custodian so your ownership has another counterparty involved.

Read more: Gold Mining Shares vs Physical Gold Bullion – Which to Buy?

If you’re serious about investing in gold mining shares or stocks, then we’d recommend you check out our favourite financial newsletter writer. We have been a subscriber of his for over 10 years. Learn more about him and the special deal he has offered our readers here.

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Gold Futures vs Physical Gold

What are Gold Futures, Options and CFD’s?

Gold futures contracts allow producers, miners and end users of gold and silver to hedge or to mitigate price risk. But they also allow speculators to “bet” on the future price of gold or silver.

Futures also involve leverage so you get exposure to the gold price that is greater than the sum you invest.

Likewise options and CFD’s are derivatives that give leverage to the price of gold.

Disadvantages of Gold Futures and Options

  • Margin – while you get leverage to the upside in the gold price, if the price falls this also magnifies your losses. You can potentially lose your entire investment.

Advantages of Physical Gold in your Possession

Physical gold advantages over paper gold
Physical gold has distinct advantages over paper gold.

There are a number of advantages of physical gold over paper gold.

But the key advantage is that physical gold in your possession has no counterparty risk. That’s what makes physical gold (and silver) the only financial asset(s) that qualifies as financial insurance.

For more on the reasons to hold gold for financial insurance and the 5 benefits see: Why Gold Bullion is Your Financial Insurance 

Other Advantages of Physical Gold Over Paper Gold

  • Once you’ve bought you know your costs. You know your purchase price and your storage costs (if any).
  • Physical gold takes some effort to sell – you can’t just click a button to sell physical gold.  Some may see this as a disadvantage compared to say a share or an ETF. However as it takes a conscious effort to sell, you won’t sell impulsively and without giving it due consideration.
  • No management fees – unlike gold funds and ETF’s.
  • Unlike paper gold, physical gold won’t go to zero. History shows it will always have value.

What Type of Physical Gold to Buy?

Once you’ve decided to buy physical gold you also may wish to consider exactly what type of physical gold to buy. Here are some factors to consider:

But it’s not as complicated as that might seem. You can always just get our thoughts. Either use the live chat below or pick up the phone and give us a call on 0800 888 465 (Outside New Zealand: + 64 9 281 3898).

Or browse the gold products available in our online precious metals shop.

If you need more information on the process of how to buy physical gold see: How to Buy and Invest in Gold.

Editors Note: This article was first published 1 August 2018. Last updated 26 August 2020.

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