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Investing in Gold versus Gold Exchange-Traded Funds

As various fiat currencies around the world lose value, and fears of a looming financial crisis are growing, investors are seeking safer investments to keep them afloat in a crisis. In circumstances like these, many investors favor gold; while its price is quoted in dollars, it’s valued globally, and it has no counterparty. But if you’re considering adding precious metals to your holdings, first consider the pros and cons of buying physical gold or gold exchange-traded funds.

Physical Gold

Pros: Physical gold is easily converted to cash, and easy to transport– especially since small quantities carry relatively great value. It can be divided without losing value, and it enjoys consistent value with no expiration date. Physical gold can be privately held and kept in confidentiality.

Cons: Traditionally, physical gold buyers have had to find a reputable seller, pay for the gold’s secure storage, and arrange for its shipping, delivery, and insurance. And buyers were often required to have the purity of their purchase tested, to make sure they got what they were paying for.

These days, online options streamline this process considerably. Several full-service firms now allow investors to purchase and store their gold in a single place, includingHard Assets Alliance’s SMARTMETALS platform. The platform has additional services that investors can access 24 hours a day, seven days a week.

Gold ETFs

Pros

Gold ETFs are great for small investors, investors just getting into the gold market, and those who want to diversify their investment portfolio without the bothe of managing their gold after they’ve purchased it. Since ETFs function like mutual funds, investors can purchase gold ETFs with a small amount of capital, limiting their investment risk.

Cons

While gold ETFs are touted as a hedge to tumultuous economic times, they are likely to suffer from the same calamities they are expected to protect their investors against. A host of features can hurt these investments’ value: the ETF’s management, the chain of custody, operational integrity, regulatory oversight, delivery protocols, whether it is adequate insurance banking the gold that backs the ETF, the security of the gold backing the ETF, whether there is sufficient gold to back the ETF, and illegal activities by the bank/investment firm running the ETF.

Gold ETFs are created by the same banking and investment industries from which investors seek protection. So the risks of investing in gold ETFs tend to increase as any economic crisis worsens.

For example, HSBC(SEHK: 005) has been fined for a number of illegal trading and banking activities.W ould you trust a bank that has been found guilty of money laundering, violating bank secrecy laws, manipulating benchmark rates used in FOREX trading, and helping wealthy clients to evade taxes in several countries to properly look after your gold ETF investment?

Also, although some physical gold ETF investors own the portion of gold that they invest in, they cannot demand physical gold in exchange for their shares. Moreover, the gold ETFs track the performance of price of gold. Thus, they are not designed to outperform gold mining stocks. And when gold mining stocks begin to climb, the performance of gold ETFs may lag behind them.

All that glitters…

If you can afford the costs, physical gold is your best hedge in a financial crisis. But if you can’t, a gold ETF is your next best option– as long as you do your homework on the firm managing the ETF. HSBC is not the only bank that has been found guilty and fined for violating banking laws, investment laws, and international laws. Notably, even the agencies that are supposed to watching the banks and investment firms have fallen short of adequately protecting investors.

It’s always good to diversify your portfolio, hedge your investment bets, and maintain access to different markets using different investment products. Just make sure you know the risks of the investment strategy you choose, and try to protect yourself against those, too.

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Disclosure: Alisa Hopkins doesn't own any shares of companies mentioned. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance.