Physical Gold vs. ETFs: Why Central Banks Hold the Real Thing

MIKE BARNES 0:21

Welcome to America’s Gold Authority Podcast. My name is Mike Barnes. When we talk about gold, you may picture gold coins or maybe gold bars like you’d picture at Fort Knox. But what about ETFs? Why are they popular? But why do central banks use the real thing? Let’s talk about that with a couple of experts. Philip Diehl and Brad Chastain join me now. And Philip, as the 35th Director of the United States Met and president of U.S. Money Reserve, what is the deal about ETFs that make them so, so popular?

PHILIP N. DIEHL 0:50

Well, they they have really been tailored made for people who like to trade in gold on a short-term basis. So they’re not really uh for the uh people like us who who buy and hold gold for the long term, for the financial security it provides, for the price appreciation over the longer term. Uh it’s really designed for uh sophisticated traders, traders who use uh uh high-frequency trading algorithms and uh and sophisticated models for predicting short-term prices. And so they were designed uh so that people can move uh in and out of uh investing in the price of gold. Although when you purchase an ETF, you never actually own gold. You simply have a contract that gives you the right to the price of gold whenever you uh sell the contract.

MIKE BARNES 1:52

ETFs, exchange traded funds. It sounds like something that central banks would like, but they don’t, do they, Brad Chastain?

BRAD CHASTAIN 1:59

No, ETFs aren’t really something that central banks use a very, very minimal level for very specific uh purposes, but not as a core part of their reserve holdings like gold is. They prefer physical, they specifically prefer good delivery, um, what’s known as good delivery bars on the the London Um Bullion Market Exchange, the LBMA. And um there are reasons for that. One of them is a big one is counterparty risk. Owning physical gold in your own physical vaults uh does not have any counterparty risk. To Phillip’s point, the uh ETFs, you don’t actually own gold. You own a share of a trust that then owns the gold. And there is counterparty risk involved in many layers of that process, in fact. So when they own actual physical gold, there’s no counterparty risk, uh, especially when it’s held within a country’s own borders, there’s no sanction risk against it. Uh a paper-driven product on an exchange could theoretically be still be sanctioned, uh, just like we saw with Russia and uh their foreign FX reserves uh more recently. So um, for all of the reasons that central banks want to own gold, physical makes sense for them.

MIKE BARNES 3:21

Philip, I know you’ve looked closely at what central banks do, and you have a graph that shows how they’ve purchased physical gold through the years.

PHILIP N. DIEHL 3:29

Yes, this this graph goes over a 20-year period and it breaks it down into four or five-year periods, and it really shows the uh the dramatic change in policy for the central banks and their gold buying. Back in the first five years of the period, you see on this graph that they actually were net sellers of gold. In fact, before that time, they were big net sellers. If we went back in time beyond 20 years, that red bar would be much larger and it would get larger over time. But over the last 15 years, they have significantly changed the whole market for gold because they have become consistent buyers. You see in the two middle bars that they jumped up to about 500 tons a year, and then they have averaged a thousand tons a year over the last five years, and they’re on pace this year for another thousand tons. Well, what that has done is it has put a floor underneath gold prices. First, it drove them up, it contributed to price increases, but then here this year, when we have seen a pullback in gold prices, it set a hard floor for how far gold would fall. When one factor in why gold fell over this year was because the Chinese changed their policy on uh on uh leverage trading in gold. And so that undercut uh uh demand a little bit. It didn’t really impact demand, but it significantly increased the supplies that were available as those trades in China War I unwound. But that is past now, and and we’ve seen that uh floor really exert itself over the course of the spring and as we’ve gotten into the summer. So uh when you look at what has happened, the dynamics behind gold prices over the last uh 10 years or so, uh, the role of central banks and their increasing of gold prices is a really big factor.

MIKE BARNES 5:46

And Brad Chastain, it seems like central banks being only in physical gold for the most part, it seems like it would turn people away from ETFs, and yet so many people still try to buy them.

BRAD CHASTAIN 5:58

Yeah, I ETFs are are convenient, and they’re something that people uh largely are familiar with that they’ve traded stocks because they’re they’re bought and sold on exchange through brokerage accounts, and just it’s literally no different than buying a stock. And so that uh familiarity is is what lands people there and even direction through financial advisors. So a lot of times when people want to get uh gold exposure, a financial advisor also is typically more familiar, they’re quite familiar with ETFs in general, so to them that just kind of makes logical sense. So you see a lot of that just from that familiarity standpoint drawn there. You know, for long-term holds, physical really like central banks do, physical really, really makes sense. It removes the the counterparty risk, but it there’s also fees involved, right? ETFs, just like an exchange traded fund or a mutual fund, has what’s known as an expense ratio. It’s the money that comes out for managing the fund itself. And uh those are drags on performance over time because as the fees come out, it’s not something that you see on a statement. You don’t see that you’re paying it, but you pay it because the performance is that much lower. It comes directly off of the performance, and then compounding is slower. And the differences over time are substantial. I mean, GLD, the largest gold ETFs, has a expense ratio of 0.4%, so a little less than half a percent per year that’s paid. And when you compound that over a long period of time, I mean, as an example, you know, investing in gold back in 2004 and holding it for the last um 20 plus years, you actually would have seen a huge, huge difference. In fact, it would have cost over $26,000 in growth of the account paying those fees, because it also goes up as the account grows, because it’s taken as a percentage. So as the account is larger, the amount that’s the dollar amount that’s taken out is in fact larger. Um, and when you hold physical gold at home, obviously don’t have that. If you have physical gold in an IRA, there are that has to be held in an IRS approved depository. And so there are custodial fees with that. US Money Reserve, we work with one of the largest uh self-directed IRA custodians, and we’ve actually negotiated fees down lower than other gold providers have. So it ends up being currently $235 uh per year. So the break-even on an ETF versus that is about $56,000. So once somebody has about $56,000 in gold ETF or more, they’re paying the same or more as that flat fee. But that doesn’t grow in the IRA like the ETF fee does. So today, for example, the that account would now, and if you invested back then, it would have been uh closer to $450,000 account balance, and the fee still just at $235. Whereas that’s over $1,000 a year taken out at this point from the uh the gold ETF. So it ends up being substantial. It’s not just the amount paid, but it’s also the amount that it’s removed that you no longer get to compound and grow um over time. So it ends up being quite substantial.

PHILIP N. DIEHL 9:08

I’d like to jump in on that point uh and uh and address an issue that I hear uh often. When you have physical gold, you there are custodial fees. I mean, you have to s unless you you know keep it at home or buried in the ground. You have it in a bank. And and I kind of laugh at this idea because uh a one-ounce gold eagle costs over $4,000 now. And so if you, you know, if you had $56,000 in gold and gold eagles, you’re talking about 13 coins. You could easily have $100,000 in gold coin, and uh it would be very simple to keep those in a uh in a safe deposit box you already have in the bank. So these the whole idea that there are significant costs to holding gold uh in a bank is really uh nonsense these days.

BRAD CHASTAIN 10:09

Another one that many people aren’t aware of, and even I’ve found financial advisors aren’t aware of, is the taxes on them as well, because people tend to think they do the taxes work exactly like any other ETF, and that that’s not really the case. Um inside of an IRA, that is not relevant, of course. Uh, but outside of an IRA, that fee that we’re talking about that’s taken out, the way that that fee is paid is by actually selling gold from the trust. And when that gold is sold within the trust, it flows through to the owner as a sale. So even if you don’t sell the ETF, normally if you buy an ETF, it’s say the S P 500 or or something else, you’re not gonna pay any taxes until you go sell it. Um, except on any dividends that are that are received, of course. But since the gold doesn’t pay dividends, people think, hey, there’s no taxes until I go sell the ETF, and that’s not the case. The gold that’s sold to pay that fee every year passes through to owners, and that’s actually taxable each year without even selling it. So in the case of that account we talked about earlier, that’s now over $1,200, over $1,200, in fact, um, is what it would be in annual fees. That’s an extra twelve hundred dollars that has to be taxed at this point in time in a non-taxable account, so or in a non-tax deferred account. So um something people don’t think about. And because it’s selling the gold from the trust, the the shares represent uh the shares portion of gold in the trust is actually declining over time. So the the the gold is actually sort of uh or the the share value of gold is actually diluted over time as it is sold out off very, very slowly. So um those are things that even financial advisors, when they put folks in ETFs, typically are not aware of because it does work quite differently than the ETFs that they’re used to.

PHILIP N. DIEHL 12:05

This is one of the reasons why I enjoy the these uh podcasts, is that I learned something uh about this business uh almost every time. And this is this the the tax treatment that Brad has described here is something that I was unaware of. And that is really a substantial disadvantage to ETFs. And as Brad says, a lot of these details the uh that financial advisors are not aware of. And the other thing to bear in mind is that financial advisors have their own financial interest in what they sell. Uh and uh when an uh investor buys gold and holds it for a long period of time, uh there’s no training, the trading fees that are uh that are hand that are you know received by the financial advisor. Whereas with ETFs, when you’re moving in and out of those, uh then you’re incurring the tax implications, you’re incurring the fees uh that ETFs charge on an annual basis, and and also you’re you’re uh usually paying a uh a fee to your financial advisor for moving funds about.

MIKE BARNES 13:25

There are so many factors out there, but a lot of people look at it and think, oh, well, it’s just the modern world. It’s like you used to write checks, now we use Venmo all the time. Well, I used to buy physical gold, now I just have an ETF. It’s just it’s like an email and it’s worth a lot of money. But Brad Testing, you’re telling me that that’s not really the best case to do if I’m investing all of my money long term in an IRA.

BRAD CHASTAIN 13:48

Yeah, I don’t believe so long term for a number of the reasons that we just spoke about. Um, I mean, ETFs honestly can make sense and be the better option if you’re looking for a short-term trade. If you think gold’s gonna go up next week and you’re looking to get in and out, um ETF is probably the right choice in that in that avenue. Hedge funds largely use them because hedge funds are always looking, you know, short-term sort of strategic trading. They have to move around very, very quickly, and and um they’re looking, you know, a year or less out oftentimes because their performance is is measured on those sorts of time frames. And that sort of extra cost erosion uh doesn’t really impact you much over a one-year period of time. But um if you’re looking long term, then the disadvantages really, really add up. And that’s really who our we help. We help folks that are focused on long-term um uh planning as well as generational wealth, and that’s where the physical really shines over ETFs.

MIKE BARNES 14:51

So, Philip, if my financial advisor says, oh, go ETFs, that’s what you need long-term, what do I need to tell him or her?

PHILIP N. DIEHL 14:58

One thing you can tell them is that you want to hold uh physical gold for the same reason that central banks all over the world do. And that is for the long-term uh financial security that they represent, uh, for the long-term financial gains that come with gold, which over the last 25 years has matched the S P 500. And uh, based on the analysis and a consensus analysis by financial advisors, the name brand guys, these are not just people in the gold industry. The name brand independent advisors are looking ahead over the next five years or so, and uh they’re saying that gold is expected to far outperform the S P 500. The SP 500 simply won’t grow as fast as it has over the last five to ten years. Those appreciation rates are not sustainable, but the way the world is turning today is much more, as we all know, is much more volatile, and there are many more threats in the world to our economic well-being. And um, in that environment, gold provides much more security to people. Also, they need to tell them that uh they’ve studied up on uh physical gold and uh and ETFs, and there are all these uh fees and and uh and and uh and taxes uh implications that come with ETFs that they want to avoid by buying gold and holding gold for the long term. So I think it’s important that they express to their financial advisors that they really know their business on uh gold and this substitute for gold, that’s what they really need to be saying, is that I don’t want to have a contractual claim to gold that uh, you know, can be worth nothing or a lot less if somebody in the whole chain, and there’s often five or six companies, not just the company that is the trust fund for the gold in an ETF, any of them go bankrupt, then your uh investment in the ETF is placed at risk. Um and with fiscal gold, you don’t have that kind of counterparty risk. You own the gold, you don’t own a paper contract. And you hold the gold yourself at home or in an IRA in a uh depository or in your uh in your bank in a safe deposit box.

BRAD CHASTAIN 17:55

It’s kind of like you know, if you buy stock in Apple, the company Apple, you’re technically, by all legal definition, an owner of Apple. But that doesn’t give you right to go in and take an iPhone off the shelf as an owner of Apple. Gold ETFs are very similar. You own a share of a trust that then owns the gold. But you can’t go in and just get the gold. You don’t own the gold, you own the share of the trust that owns the gold.

MIKE BARNES 18:23

Good comparison. You’ve both cleared up a lot of things for a lot of people. Thank you so much, Philip Diehl and Brad Chastain. Thanks, Mike. Thank you, Mike. We learned a lot about ETFs. Short term, they may be okay for you, but long term, especially with those fees, it may not be the thing to do. Stick with that physical gold. That’s all the time we have for today’s episode. On behalf of all of us here in the U.S. Money Reserve Studios, I want to thank you so much for tuning in. If you have any questions or you want to learn more about today’s episode, you can call the number in our episode description and speak with one of our friendly account executives. They’re going to be more than happy to answer any questions you may have about precious metals and the strategic role they can play in achieving a secure and comfortable financial future. I’m Mike Barnes. We will see you next time on America’s Gold Authority Podcast.