ETFs No Substitute for Physical Gold in a Crisis

Gold-backed exchange-traded funds (ETFs) generally follow the price of gold. As a result, they have been underperforming relative to the general stock market this year.

For instance, SPDR Gold Trust (GLD) lost about 28.3% of its value in 2013, fell another 2.2% in 2014 and yet another 3.8% so far this year. It was recently trading at $109.72 per share.

ETFs are backed by physical gold held by the issuer, and are traded on the market like stocks. They allow investors to play gold without having to buy full ounces of gold at spot price. Since their purchase is just a number in a computer, they can trade their investment into another stock or cash pretty much whenever they want, even multiple times in the same day. Many speculative investors appreciate this liquidity.

There are also gold mining ETFs that track the value of gold mining companies and also generally follow the price of gold. These are very popular with speculative commodity investors and some of the most popular hit record lows this past summer, like the Market Vectors Gold Miners ETF (GDX).

With gold ETF prices being so low, many of Peter Schiff’s clients have asked if they should be investing in these ETFs.

There are good reasons to invest in ETFs, but they aren’t a substitute for owning physical metal. In an overall investment strategy, SchiffGold recommends buying gold bullion first.

When considering gold-backed ETFs, you should always keep in mind that you don’t actually own the gold. Buying the most common ETFs does not entitle you to any actual amount of the precious metal.

Having physical metal in your possession is particularly important in the event of an economic meltdown. Think about it: what would you rather have in your possession during a crisis – a piece of paper, or a physical asset recognized as real money all over the world?

Gold-backed ETFs are prized for their liquidity and ease of transfer, but during a period of economic chaos, those characteristics would likely vanish. Crisis creates uncertainty. Panicked people won’t value paper that may or may not represent a tangible asset. But they will value physical metal that they can hold in their hands.

In the event of an economic collapse, barter could become an important means of conducting business. That’s exactly what happened in Greece during its economic meltdown. You can use gold coins and easily barter in an emergency. People all over the world recognize gold as money. It’s much less certain that you would be able to liquidate an ETF during a time of crisis.

Consider a case a dollar collapse and hyperinflation. The rapidly rising price of consumer goods, from groceries to gasoline, would make day-to-day living very difficult. Even if you managed to liquidate your gold-backed ETF, the currency you pull out would rapidly lose value. Physical gold, in your hand, would be immune to the government’s printing press. In all likelihood, your gold would buy you the same basket of goods and services a month, or even a year later. The cash you pulled from your gold-backed ETF would likely purchase far less as time goes on.

Although gold-backed ETFs offer an easy way invest in the precious metal, you always have to remember that you don’t actually own what you can’t hold in your own hands. There is always “counterparty risk.” The fact you possess an ETF does not give you the right to redeem it for actual gold. The owner of the gold is backing your investment, and promising to pay you dollars.

Physical gold offers stability and certainty in your investment. You can put a gold coin in your pocket. With a gold-backed ETF, all you really have is a piece of paper representing a legal promise. That’s well-and-good in normal market conditions – but in a real emergency, promises are easily broken.

Gold-backed ETFs have a place in an overall investment scheme. But for security in the event of a crisis, they simply cannot replace physical gold.

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