What is Paper Gold – And is it a Good Investment?
At a Glance:
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- Paper gold refers to a a method of investing in gold without holding the physical metal.
- Gold ETFs, futures, and stocks are common examples of paper gold.
- While paper gold cuts down on investing costs, it also increases counterparty risk exposure.
What is Paper Gold – And is it a Good Investment?
Paper gold refers to non-physical gold products. Common examples of paper gold include Gold ETFs, futures, and stocks. By buying paper gold, investors can profit from gold price movements without physically possessing gold bars or coins. There are advantages and disadvantages to buying paper gold – just like with any other investment.
While paper gold can decrease the upkeep and storage costs of gold investing, it also increases your counterparty risk. Because paper golds only hold value when the exchanges and companies managing them exist, this method of investing relies heavily on the strength of the traditional stock market.
Most gold stackers recommend buying physical gold, but that doesn’t mean it’s the only way to invest. Today, we’re taking a look at paper gold, as well as this unique gold investing method’s strengths and weaknesses.
Understanding Paper Gold
Using paper gold, consumers can invest in gold without having to take physical possession of the precious metal. Paper gold works a lot like traditional stocks, ETFs, and futures. When you buy paper gold, you’re buying a “share” in the current price of gold. When gold becomes more valuable, you’ll profit. And when gold’s spot price decreases, you lose money.
That’s the basic rundown, but paper gold is a bit more complicated. There are several types of paper gold, and each one comes with its own benefits and drawbacks. To determine whether or not paper gold is a good investment for you, you’ll need to understand the different ways to invest in this alternative form of gold. Below, we’ll explore the three main categories of paper gold investments available to consumers.
Types of Paper Gold
There are three main types of paper gold:
- Gold Exchange-Traded Funds (ETFs)
- Gold Futures
- Gold Stocks
Paper gold is very similar to traditional assets traded on the stock market. ETFs, futures, and company stocks are some of the main ways investors build their portfolios. If you’re interested in buying gold but don’t want to be responsible for safeguarding gold coins and bars, paper gold is an excellent option.
Gold Exchange-Traded Funds (ETFs)
Gold ETFs are a popular way to invest in paper gold. When investors buy a gold ETF, they own a “share” of the fund’s total collection of physical gold. Generally, ETFs pay dividends. This means that a small portion of profits from the ETF are divided up amongst shareholders. ETF dividends are paid based on the number of shares that each shareholder owns.
When you buy a gold ETF stock, you don’t actually own physical gold. Instead, ETF investors own a small percentage of the ETF’s gold portfolio. When the price of gold goes up, the value of a gold ETF increases as well. The company behind an ETF is responsible for procuring new gold products, safeguarding their portfolio, and paying dividends to their investors.
Gold Futures
A “future” is a method of investing that involves betting on the future price of a security or commodity. By buying a gold future, you’re promising to pay today’s gold price for a gold product on a predetermined future date. If the price of gold goes up before that date, future contract holders can sell that future for a profit. If it goes down, they lose money.
Gold futures are an excellent form of paper gold for investors who don’t want to worry about an exchange managing their gold. Like with other paper gold types, gold futures don’t give investors any physical gold. For the most part, gold futures allow investors to profit from gold’s price movements without taking physical delivery of gold coins and bars.
Gold Company Stocks
It is also possible to invest in paper gold by buying shares in gold-producing companies. Some private mints are publicly traded, so investors can buy gold stocks in those companies. Another popular way to invest in paper gold is to put money into publicly traded gold mining companies. Because a higher gold spot price increases profit margins for gold producers, gold company shareholders make money when gold appreciates in value.
Not all gold manufacturers and mines are publicly traded on the stock exchange. Some gold producers might not be profitable – even during times where gold prices increase. In other words, investing in gold company stocks can be complicated. To invest effectively in gold companies, investors should consider both the gold market’s prospects and the viability of each company.
Is Paper Gold a Good Investment?
Paper gold is sometimes a good choice for investors – but not always. Buying paper gold means that investors spend less money procuring, securing, and storing their gold, but it also increases counterparty risk.
Let’s take a closer look at the pros and cons of investing in paper gold.
| Pros of Paper Gold | Cons of Paper Gold |
|---|---|
| Traditional Investment Type | Counterparty Risk Exposure |
| Easy to Buy and Sell | No Physical Possession |
| Small or No Premiums | Confusing For New Investors |
| No Storage/Cleaning Costs | Not Collectible |
Advantages of buying Paper Gold
The appeal of paper gold is easy to understand – paper gold means stackers can profit from gold price movements without having to physically possess any gold. For investors who want to enter the gold market but don’t want to contend with premiums, storage, and security, paper gold is a fantastic option.
Paper gold can also be a tool for portfolio diversification. Because paper gold assets are linked to a physical, intrinsically valuable commodity, these stocks are a fantastic way for investors to diversify their investment portfolios.
Physical gold is always sold at a premium, but investors can buy paper gold for prices very close to the value of gold bullion. This makes paper gold a good option for investors who don’t want to lose money paying unnecessary premiums over spot price.
Cons of Investing in Paper Gold
The biggest downside of investing in paper gold is that it increases counterparty risk. Counterparty risk refers to the risk posed by entities other than an investor during the course of an investment. Typically, an investment has high counterparty risk when the one party of an investment contract might not be able to fulfill their obligations.
Physical gold comes with little counterparty risk. When investors buy gold coins and bars, they’re wholly responsible for maintaining their assets. If gold becomes more valuable, they profit. If the precious metal depreciates, physical gold stackers lose money. There’s nobody else involved!
Paper gold is different. By buying paper gold, investors rely both on the value of gold bullion and the solvency of the other company, exchange, or organization involved in a given shareholder contract. Consider, for example, that you invest in a gold ETF. After a few months, the exchange is robbed and loses more gold than their insurance covers. This is counterparty risk – the possibility that the other party to your investment contract becomes unable to keep up their end of the bargain.
Paper Vs. Physical Gold – What’s the Better Investment?
Both paper and physical gold can be good investments. Typically, gold stackers prefer physical gold because of its lower counterparty risk and higher degree of investor control. Paper gold tends to be a good option for people planning for retirement who don’t want to pay for the storage, security, or additional insurance necessary to keep physical gold.
| Paper Gold | Physical Gold |
|---|---|
| No Premiums | Premiums Over Spot Price |
| No Upkeep/Storage Costs | Can Be Expensive to Store/Maintain |
| Counterparty Risk Exposure | No Counterparty Risk |
| Helps Portfolio Diversification | Good for Portfolio Diversification |
Paper Gold: Lower Upkeep Costs, Higher Risk
Paper gold isn’t a physical asset. It doesn’t need to be cleaned, stored, secured, or insured. There’s no need to compare premium prices or vet dealers when you buy paper gold assets like a gold ETF or gold futures contract. Lower upkeep costs are one of the biggest advantages paper gold has over physical gold. Paper gold offers the same portfolio diversification as physical gold – but without some of the unnecessary costs.
However, paper gold also requires investors to tolerate an elevated level of counterparty risk. If the company or exchange behind your paper gold investment goes belly-up, you risk losing quite a bit of money for something outside of your control. By contrast, physical gold gives investors total control over their profits.
Physical Gold: Full Control, Higher Premiums
For centuries, physical gold has been the standard for investors. Gold ETFs and other forms of paper gold are relatively new inventions. Until paper gold became a fixture of the stock market, most investors used gold to diversify and shield their portfolios from inflation and geopolitical insecurity.
Part of physical gold’s appeal is the degree of control it offers investors. When you buy gold coins or bars, your finances are (literally) in your own hands. Even if the mint who produced your gold bar files for bankruptcy, you still own physical gold – and that gold still has value. This peace of mind comes at a price, though.
Physical gold is always sold at a premium over spot price. While it’s possible to buy low premium gold, every gold coin or bar on the market comes saddled with some sort of additional fee over its melt value. Some investors consider these premiums a worthwhile investment for the control and peace of mind offered by physical gold. To other investors, paying a premium is wasted money that could be better spent on paper gold.
How to Buy Paper Gold
Paper gold is traded on most major stock exchanges. Buying paper gold works a lot like buying any other stock, ETF, or futures contract. You’ll need to pick an exchange, perhaps work with a licensed broker, and add funds to your account in order to purchase paper gold assets.
Choosing Between Gold ETFs Vs. Futures
Gold ETFs and futures are both forms of paper gold, but they work differently. When you buy a gold ETF, it works a lot like any other ETF stock. Over the course of each year, an ETF distributes percentages of profits to shareholders in the form of “dividends.” Gold ETFs utilize the same structure, but the fund surrounds a collection of different gold products.
When gold becomes more valuable, each investor in an ETF is paid dividends relative to the number of shares they own. For traditional investors who want to diversify their portfolios with gold, gold ETFs are a great way to merge traditional stock benefits with the intrinsic value of gold bullion.
Futures are different from gold ETFs, but they still follow the same general rules used in the traditional stock market. A gold futures contract is an agreement to pay today’s gold spot price for an amount of gold set for delivery at a future date.
Gold futures give you more control over your level of exposure, but ETFs pay dividends and follow a more traditional profit distribution system. We also recommend gold ETFs to people who are new to trading paper gold. Futures can be a great way to build your portfolio, but it takes a bit of experience to navigate – and execute – a gold futures contract.
Buying Paper Gold Through an Exchange
Most traditional exchanges now offer paper gold options. Investors who want to expand their portfolios with paper gold should take a look at some of the most popular stock exchanges to see what options are available to them. Stocks in gold companies, gold futures, and gold ETFs are all excellent ways to get started investing in paper gold assets.
Is Physical Gold Still the Best Way to Invest?
Despite the benefits of buying paper gold, most investors advise that newbies stick to physical gold. There are a couple of reasons to prefer physical gold to paper gold. First, there’s nothing that quite compares to physically holding gold bars and coins. The level of control offered by physical gold is unmatched by paper versions of the precious metal.
Buying physical gold is both an investing strategy and a hobby. The beauty of a quality gold bar or coin is tough to beat – even if your primary motivation is profit. To decide whether paper gold or physical gold is right for you, think about your investing objectives.
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About The Author
Michael Roets
Michael Roets is a writer and journalist for Hero Bullion. His work explores precious metals news, guides, and commentary.