For too long, a hardcore constituency within the gold bug community has rejected anything but physical bullion. This, they claim, is the only way to protect themselves from a global currency meltdown or some other kind of catastrophic event.
If you’re unfamiliar with gold bugs, they tend to be a paranoid bunch. Whether it’s some nefarious force that’s manipulating market prices or political events, they gain great comfort from conspiracy theories, which in turn is always a bullish setup for prices of precious metals.
Annual 2016 demand for gold-backed exchange-traded funds and similar products was the second highest on record at 532 tonnes, according to the World Gold Council. Yet, despite their perennial love affair with metals, many gold bugs still flatly reject the idea of a third-party custodian storing their precious metals in a secure vault they can’t see. Let’s examine a few reasons why goldbugs should adjust their hardcore stance against ETFs linked to metals.
Liquidity
The first strike against owning physical metals is limited market liquidity. Typically, that market liquidity is driven by what one gold dealer or pawn broker is willing to pay for your gold. In contrast, converting a precious metals ETF happens very quickly with a brokerage order to sell.
What about the cost of liquidity? The largest gold ETF, the SPDR Gold Shares (GLD), had a recent bid/ask spread of just 0.02 percent, according to Morningstar. On the other hand, gold dealers that buy or sell physical bullion make their profits by charging stiff premiums that well exceed the daily bid/ask spreads on ETFs like GLD. So steep transaction costs cut into whatever profits gold bugs are able to eke out.
Storage
Acquiring physical gold is one thing, proper storage is another. The issue of gold storage is a very serious matter and is further complicated for investors with limited storage space or inadequate security.
Whether gold bugs choose to store their bullion in a private secure vault at their local bank or at home, the annual and ongoing cost of storage and insurance gracefully erode performance returns. In contrast, investors in gold ETFs pay an annual expense ratio, which in most cases is substantially lower than what physical bullion owners pay to store and insure their gold assets. The ETF fees cover management costs, including bullion storage.
Income
A lack of dividend income is a nagging disadvantage of investing in physical precious metals. And although physical ownership of gold may feel like it gives more control, from an income perspective, it’s highly restrictive to investors.
On the other hand, gold ETFs offer far more flexibility because funds that trade put/call options allow investors to generate income on their shares. For example, the strategy of selling covered calls on a gold ETF allows the investor to take a physical asset that generates no earnings or income and immediately convert it into a cash producing asset.
Convertibility
While many gold ETFs are structured to provide the convertibility of shares into physical gold only to authorized participants that trade in large blocks, a fairly new breed of funds is offering that convenience to all shareholders.
The VanEck Merk Gold Trust exchange-traded fund (OUNZ), which debuted in 2014, differentiates itself by providing investors with the choice of taking physical delivery of their gold bullion in exchange for their shares. For a fee, the investor can convert London bars into gold coins and bars into denominations they desire. Also, taking delivery of physical gold isn’t a taxable event since the investor is merely taking possession of the bullion they already own.
The ability to easily convert ETF shares into physical metals should serve as a wakeup call to crusty gold bugs.