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It is
always important to use the correct tools for the work you intend to
accomplish. That reliable adage is true whether you are building a house or
an investment portfolio.
There are many
tools available to buy gold, which is the bedrock of any portfolio. These
include coins, bars, futures contracts, certificates, options, and what has
recently perhaps become the most popular instrument of all, the gold
exchange-traded fund – the so-called ETF. But which of these many tools
is the right one for you?
The answer
to this question begins by first determining your objective. In other words,
it is necessary to identify the reasons you want to own gold. Once these are
clearly understood, the right tools can then be chosen to enable you to meet
the objective you intend to accomplish by owning gold, of which there are
two.
First,
fluctuations in the price of gold enable skilful
traders to profit from these moves, buying when they expect the price to rise
and selling in anticipation of a lower price. In this sense, gold is often characterised as an investment, but it isn’t that.
Gold is a sterile asset that does not generate cash flow. It doesn’t
have a management team or a balance sheet, so clearly gold is not an
investment. Gold is money, and therefore is part of the liquidity everyone
needs in his or her portfolio, which leads to the other reason to own gold.
Gold is a
safe haven. It does not have counterparty risk. Because it is a tangible
asset, its value does not rest upon someone’s – or more to the
point – some bank’s promise. When you own gold, you own money
completely outside the banking system.
From the
above two observations, you may be starting to sense that there are actually
two types of gold: paper gold and physical gold. The former is a financial
asset, which means it has counterparty risk. The latter is altogether
different. Physical gold is a tangible asset, and consequently, it therefore
does not have counterparty risk. Only physical gold provides a safe haven.
So do not
view any of the gold ETFs as an alternative to physical gold, because they
are not. The ETFs meet the first objective by providing exposure to the gold
price, but they are not a safe haven. The ETFs should be compared to a gold
futures contract, not to physical metal.
A futures
contract tracks the future price of gold in the form of a tradable contract.
In a similar vein, an ETF tracks the spot price of gold in the form of a
tradable security.
I favour the concept of a gold exchange-traded fund, just
as I think a futures contract can be useful. But one needs to choose the
right tool for the right job. Physical metal is one thing, and the paper
representation of metal in an ETF that simply tracks the gold price is something
entirely different. Importantly, it is physical gold itself – and not
just the promise to pay metal – that is the bedrock asset of one's
portfolio.
Consequently,
use gold ETFs as you would a futures contract – as a trading tool. It
is not an alternative to owning physical metal. If you want to own gold
because of its safe-haven attributes, then buy physical metal
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