Which is a better investment in gold – physical or derivatives?

Which is a better investment in gold – physical or derivatives?


Investing in gold has come a long way from keeping the physical metal in gold coins, bars or bullion. In this segment we explore the various options an investor has when putting money into gold. Let’s look at each investment and weigh its pros and cons.

Physical Gold

Investing in physical gold offers the most direct exposure to gold price. By owning physical gold, you have direct ownership of something that has palpable value and instant liquidity.

The most traditional way of investing in physical gold is by buying gold bullion which includes bars and coins. Bullions are precious metals in the form of bars or other storage shapes. Essentially, it is a recognised weight and fineness of gold that investors can purchase at the current gold price, plus a small premium which represents the costs incurred in refining, fabricating and shipping.

Bullion coins are priced according to their fine weight with a premium based on supply and demand. They may be purchased from a variety of dealers. Bullion gold bars, on the other hand, are available in various sizes and can be bought and sold at major banks or from bullion dealers. They are likely to carry less of a premium than coins, making them the more attractive proposition for investors. Bigger bars generally have lower premiums compared to smaller ones although they provide less flexibility when it comes to liquidation.

The disadvantage of owning physical gold as an investment is security and storage as well as the assaying fee to verify the gold that may be required when selling the metal.

Exchange Traded Products

Exchange traded products (ETP) are securities which are derivatively priced and traded on Exchanges. Gold exchange-traded products may include exchange-traded funds (ETFs), exchange-traded notes (ETNs), and closed-end funds (CEFs) which are traded like shares on the major stock exchanges. Over the last 12 years, gold ETP market has grown to rival other gold market sectors. The most popular gold exchange- traded product in ETFs are open ended mutual funds that are passively managed and that seek to mirror the return of an index, a commodity or a basket of assets. They enable investors to gain exposure to the gold price, on a real time basis and at a lower cost than many other forms of investing without the inconvenience of storing physical bars. As a passive investment, it is closely related to the performance of gold bullion- its returns closely correspond to the returns provided by physical gold. Each unit is approximately structured to equal the price of 1 gram of gold.

They are also a potentially cheaper transaction compared to other available gold investment vehicles as the expenses incurred in buying and selling gold ETF are much lower. Its ability to be traded like shares make it a highly liquid investment and is ideal for retail investors as the minimum lot size to trade is one unit on the secondary market.

Gold Saving Passbook Accounts

Gold Saving Passbook Account (GSPA) is another alternative to have in an investor’s investment portfolio. A gold saving passbook account functions like a passbook savings account offered by local banks. The main benefit of this method is that investors do not need to bear the risk of investing in physical gold. GSPA is one of the ways for a customer to build up their personal gold portfolio by purchasing small amounts of gold on regular basis over their desired period of time. For example, investors are able to buy in small amounts as low as 5 grams at a time. This ‘cost averaging’ will ensure that the total gold investment will be acquired at the average gold price. In addition to that, the gold prices quoted will be pegged to international gold prices without the usual additional charges. Investors need to be aware and compare the spread charges (cost between buying and selling) the Banks charge when investing in a GSPA.

Gold Mining Company Stock

Another way to get exposure to gold prices is by investing in gold mining companies. The value of the stock is driven significantly by the price of gold. Investors have the advantage to get a leveraged play on gold since many gold-mining stocks move much faster than the price of the metal itself. However, investors should be aware that physical gold bullion and gold mining companies stocks are two separate asset classes. Physical gold is a tangible asset while gold mining companies stock functions like paper gold and their value is affected by the global economy or the company itself. In other words, they are exposed to systemic and market risk. For instance, when buying just one gold-mining stock, investors are not only betting on gold, but on the company’s management too. If the company makes a costly error in developing an unprofitable mine, for example, then the investor could see their investment fall in value even as gold rises.

Gold Unit Trust Fund

There are two major types of gold funds: mutual fund and ETF. Gold mutual funds are managed by professionals who can assess the relative merits of investing in bullion and equities after doing research and continuously monitoring their portfolio on a regular basis. By owning gold mutual funds, investors are exposed to a variety of gold-mining stocks instead of one. Hence, diversifying holdings of gold mining stocks can mitigate the company-specific risk. An investor’s portfolio is thus not dependent on the performance and profits of one or two individual gold mining companies. Investing in this way will allow investors the advantage of stocks being chosen and traded by professional managers with industry-specific knowledge.

Gold Futures

Another popular way to trade and invest in gold is through the futures market. The gold prices we see quoted in the headline news are taken from the latest trades of futures contracts especially from COMEX Gold traded on the Chicago Mercantile Exchange (CME). What distinguishes the gold futures market from other commodities futures is that very little physical gold is delivered. Most of the contracts are liquidated before the final settlement and will not involve the delivery of physical gold.

The three largest gold futures markets are the COMEX (Chicago), TOCOM (Tokyo) and SHFE (Shanghai). Among these three, COMEX, which offers the 100 troy ounce gold futures contracts, dominates the market with 85% market share. Today, gold futures is one of the most efficient ways to invest in gold. These markets attract commercial hedgers, investment funds as well as traders looking to profit from the volatility of gold prices.

The gold futures market offer many advantages such as deep liquidity, ability to sell short, leverage as well as low transactional costs. We will explore these advantages in the next segment.

To find out more about trading in gold futures, speak to your Futures Broker’s Representative or drop us an email at rhbib.futures.bdev@rhbgroup.com