Precious Metals Trading and Investing – CFDs, ETFs, or Physical

Feb 12, 2021 06:34 PM ET
Precious Metals Trading and Investing – CFDs, ETFs, or Physical

What are some of the main ways of trading and investing in precious metals? We can broadly categorize these approaches into trading CFDs, ETFs, and owning the physical asset. This article will cover these methods in broader detail and outline the pros and cons of each.

Overview

Precious metals are one of the most valuable goods in the world. Without them, many industries like manufacturing, automotive, and jewelry would suffer. Over the years, the interesting opportunities for people to have ‘their slice of the pie’ in precious metals have broadened, which is what this article covers.

What are precious metals?

Analysts tend to separate metals into two main groups, base and precious. The main distinction is that base metals while boasting essential utility (such as copper, iron, zinc, nickel, and lead), are more common and rust quickly, while precious metals do not corrode visibly and are scarce. 

Because of their ability to maintain a high luster, their extreme rarity, and their difficulty to mine, precious metals have held incredible economic value since the beginning of recorded history.

Despite many detractors, precious metals, for most, are a financial market worth considering. Although there are at least ten precious metals, the four most commonly spoken about are gold, silver, platinum, and palladium, with particular emphasis on the former two.

The three main trading and investing methods for precious metals

We can broadly categorize trading and investing in precious metals in three main spheres; CFDs (contract for difference) or derivatives, ETFs (exchange-traded funds), and owning the physical assets. Another important consideration is the difference between trading and investing here.

Trading relies on the active or frequent buying and selling of financial instruments. This application is known to be speculative as it aims to turn a profit as quickly as possible. For this reason, CFDs are ideal for this purpose due to the ease of performing this approach. Although investing is also suited to derivatives, trading is more favorable here. 

Although we could argue various definitions, generally, investing refers to long-term buy and hold principles where the investor buys something at a lower price to sell it later for a high one. ETFs are seen as more of an investment, although they share many qualities of a typical tradable instrument. 

Lastly, owning the physical assets (typically in bullion type) is also an investment form, but this is more of a legacy practice during economic downturns.

Derivatives

By derivatives, we refer to online-traded or CFD instruments whose prices are based on a real, underlying asset. For example, rather than physical ownership, a derivative allows one to speculate or trade on its price digitally through a broker. 

Derivatives can either be traded over-the-counter (decentralized) or on recognized central exchanges such as the Chicago Mercantile Exchange. The most common types of markets here are spot (execution based on the current date and price) and futures (execution based on a future date and price).

Pros

  • One of the advantages of derivatives is there is no need to own the asset or good in question physically.
  • When we consider the barrier to entry, of all the methods, derivatives have significantly lower capital requirements due to leverage. With the countless number of brokers in existence, anyone can trade with relatively small accounts. 
  • The speed of turning a profit in derivatives is quick due to the enormous liquidity.
  • To add to the previous point, unlike simply buying an actual asset, derivatives allow the luxury of both buying and selling, allowing for profiting opportunities from both appreciation and depreciation. 

Cons

  • Most derivatives rely on margin or leverage, which is often referred to as a double-edged sword due to its capability of magnifying profits and losses.
  • Although margin allows one to control significantly more funds with a relatively smaller deposit, the long-term success rate of trading in this manner is abysmally low. Thus, the risk can magnify itself very quickly if the trader or investor does not enforce sensible risk management.
  • In most countries, capital gains tax or similar taxation is usually applicable.
  • Trading requires ample knowledge and experience.

ETFs

Exchange-traded funds (ETFs) are an index (listed on an exchange) created or managed by a financial company that tracks a collection of several underlying financial securities (such as stocks, currencies, bonds, commodities, etc.). 

In precious metals, there are several ETFs based on one or several metals. One of the most popular ones is the SPDR Gold Shares (managed by State Street Global Advisors), which tracks the gold price.

ETFs share many similarities and advantages with derivatives, such as, again, the benefit of not owning the physical asset underlying them, margin, liquidity, diversification, etc. The only exception is analysts consider ETFs more as an investment than for active trading purposes, although the latter is possible. 

Furthermore, as private companies manage ETFs, management fees are applicable, which is one of the drawbacks. Like derivatives, some form of tax will likely apply, and the excessive margin could lead to losses.

Physical

Owning the precious physical metal might be an old-school method, though many are still advocating for this approach. Questions will always arise over what it really means to own something like physical gold; is it money, is it an investment, is it for speculation, is it fear?

When thinking of owning the physical asset, most analysts specifically refer to gold (and silver to some extent) rather than other metals. Technically, gold is an investment because when sold for more than what someone has bought it for, it generates a profit. 

Though the main reason gold has long maintained its elusive status is arguably for storing value during times of high inflation and economic downturns. Notwithstanding, it is still a risky tactic because of the potentially high capital requirements for purchase and possible storage costs.

Pros

  • Unlike derivatives or ETFs, owning the physical asset mitigates counterparty risk, shielding investors away from the financial system. The tangible feeling gives investors confidence that their holding is immune to being hacked or erased.

Cons

  • As a counter-argument, there is still a significant risk directly to the owner. Depending on the amount, it is generally unsafe to keep gold in one’s home because of its high value. It is recommendable hoarders store and insure gold or silver professionally in somewhere like a bank or vault, which itself incurs extra costs.
  • Selling gold or silver is also not an easy process because several factors are measured to determine its value. Hence, one does not necessarily get the full value from the spot market price.

Conclusion

This article provides only a basic framework of what it means to trade and invest in precious metals. Each approach serves different functions; trading is purely short-term, quick profits on margin with high liquidity, and the ability to buy and sell without holding any metal physically.

Investing in an ETF is purely ‘set and forget’ long-term for capital gains and requires little knowledge. Owning the physical asset is not necessarily for profiting, but rather to maintain value in both good and bad times.


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