Commodity Trading Basics
by 5paisa Research Team Last Updated: 2023-06-28T17:03:24+05:30
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Are you considering investing in gold but unsure about the different options available? While the image of physical gold bars or a vault full of coins may come to mind, another type of gold investment called "paper gold" is worth exploring. Despite its less tangible nature, paper gold offers its own set of advantages and considerations.
When comparing physical gold and paper gold, it's not simply a matter of a hands-on versus hands-off approach. Storage, costs, fees, and maintenance must be carefully considered before making an investment decision.
It's essential to delve deeper into each option's unique offerings to determine the best choice for your investment goals. Continue reading to understand better the benefits and considerations associated with physical and paper gold meaning.
 

What Do You Mean by Paper Gold Meaning?

Paper gold refers to a financial asset that symbolizes the value of gold but does not entail actual ownership of the physical metal. Unlike real gold, paper gold lacks the backing of tangible bullion and holds value primarily in the documentation. By having paper gold, investors can gain exposure to a fluctuating gold price without possessing physical bars or coins. This investment is particularly advantageous for short-term trading rather than long-term investing. As per the paper gold definition, few examples of paper gold are gold futures accounts, pool accounts, gold certificates, and many exchange-traded funds.

What is the Benefit of Using Paper Gold in Place of Physical Gold?

Investing in paper gold offers numerous advantages compared to physical gold. One of the key benefits is the accessibility and liquidity it provides. Paper gold investments can be easily traded, making them highly liquid assets. This stands in contrast to physical gold, which requires more effort and time to buy or sell. Moreover, paper gold allows for investments in smaller increments, which makes it more accessible to individual investors. For example, it is possible to purchase paper gold in denominations as small as 1 gram or even 500 mg, whereas buying gold jewelry in such small amounts is impractical.
Furthermore, when investing in paper gold, such as gold ETFs (Exchange-Traded Funds), you don’t have to worry about the purity of the gold. Gold ETFs are required to hold an equivalent quantity of gold bullion with a minimum purity of 99.5%. In contrast, when purchasing physical gold, buyers must take precautions to ensure they receive the purity they paid for.
Another advantage of paper gold is the reduced risk of theft. Physical gold can be susceptible to theft and requires secure storage in lockers or safes. In contrast, investments in gold ETFs and e-gold units are held electronically in dematerialized (demat) form, reducing the theft risk. Similarly, gold fund of funds can either be held in demat form or with a custodian, providing added security.
 

Is Paper Gold a Safe Investment?

Whether or not it is sensible and secure to invest in paper gold buy schemes without owning the physical metal is a valid concern. This is primarily because investing in paper gold exposes you to counterparty risks.
When you invest in paper gold, such as purchasing shares of gold ETF, you receive a paper document that tracks the gold price. In such cases, the ETF, with its associated entities, may issue additional shares to alleviate price pressure. These new shares are typically backed by real gold or gold derivatives. Consequently, an upsurge in demand for ETF shares increases the number of shares available rather than a direct price increase.
Always consider the potential risks associated with counterparty failure. If there is insufficient demand for such shares and the price declines, the ETF may sell a portion of its physical gold assets to generate funds for redeeming existing shares.
When the ETF does not possess enough physical gold or encounters financial difficulties, it may be unable to fulfill its obligations to pay you for the gold shares. This scenario could lead to an ETF default. Additionally, if gold derivatives fail, the price of gold decreases significantly, or these shares' demand declines sharply, such ETFs may face challenges in redeeming all their shares. Consequently, if the fund holds less physical gold, investors will likely be caught off guard during emergencies.
It is essential to know the risks and conduct thorough research before investing in paper gold, ensuring that the chosen investment vehicle has reliable mechanisms to mitigate counterparty risk.
 

The Golden Rule

When investing in gold ETFs, it's important to choose those that offer the option for gold redemptions, although this feature may be limited. Alternatively, opt for ETFs whose shares are fully backed by physical gold. This way, you alleviate the risk associated with counterparty failure.
In addition, it is wise to strike a balance in your gold holdings. This means diversifying between physical and non-physical forms, such as paper gold, to cater to different needs, particularly for small and quick transactions. During a crash in the financial market, the price of the actual gold assets is likely to surge, compensating for any losses incurred from speculative paper gold investments. Therefore, maintaining a diversified portfolio becomes crucial in such a scenario.
By incorporating both physical and non-physical gold investments, you can safeguard against potential risks and enhance the resilience of your overall gold holdings.
 

How Can You Buy Paper Gold?

You can invest in paper gold using the following ways:

Gold Exchange-traded Funds (ETFs) 

Investing in gold ETFs is a popular method of owning paper gold. These investments are facilitated through the BSE and NSE exchanges, where the underlying asset is gold. Opting for gold ETFs offers several advantages, including cost-effectiveness compared to physical gold, which often entails significant buying and selling charges. Furthermore, investing in gold ETFs provides transparency in pricing, ensuring individuals have clear visibility into the value of their investment.
While gold ETFs generally do not impose entry or exit charges, investors must pay an expense ratio, typically around 1%, and broker charges. The expense ratio covers the fund's operational costs, and the broker charges are incurred for each purchase or sale transaction of gold ETF units.

Digital Gold  

The rise of digital gold has made this precious metal more accessible, convenient, and efficient for investors. Nowadays, individuals can purchase gold coins, bars, and jewelry online, offering a similar experience to buying physical gold but with the entire transaction in the digital realm. When purchasing digital gold, it's akin to acquiring 24-karat gold securely stored in a vault, which the buyer can access at any time through digital platforms. The gold bought online is stored in vaults by the seller, and it can be conveniently purchased or sold through digital platforms, streamlining the process for investors.

Sovereign Gold Bonds  

Sovereign gold bonds might be helpful if you wish to include gold in your investment portfolio. It offers you a 2.5% fixed interest rate along with price variations. Government securities issued in grammes are known as sovereign gold bonds. The Reserve Bank of India issues it in tranches and makes it available in paper and demat form. The simple average closing price for the week before the subscription period determines the bond's nominal value. Investing in these bonds carries no extra fees.

Gold Mutual Funds  

Purchasing paper gold can also be done by investing in gold mutual funds. Qualified fund managers run these funds and invest in gold ETFs. You may lower overall risk and diversify your portfolio with the aid of this investment.
 

Physical Gold vs. Paper Gold

Investing in each choice has advantages and disadvantages, even if possessing actual gold or paper gold may share the general stability associated with gold investments. Not everyone may do what you think is best for them. So, here are some parameters that help to find the main difference between physical gold and paper gold so that you can make an informed decision during investment. 

Parameters

Physical Gold

Paper Gold

Meaning

The purity of physical gold may vary and may not always be 99.5%.

Purity is assured and guaranteed when it comes to digital gold.

Price

Physical gold prices can vary across different sources and locations.

Digital gold prices are standardized and uniform across the country.

Investment

Standard denominations for gold biscuits or coins are typically 10 grams, requiring a significant investment for those interested in physical gold.

Investors can buy and sell digital gold based on weight or a fixed value.

Cost

When purchasing gold jewellery, additional costs of 20% to 30% of the gold's total value are incurred as making charges.

A 3% GST is levied on purchases of paper gold.

Storage

Safely storing physical gold requires a secure locker or careful storage at home, as there is a higher risk of theft or loss.

The seller securely stores the digital gold in the investor's name, eliminating the risk of theft or loss.

Liquidity

Physical gold can be easily purchased from banks or jewellers but can only be exchanged through a jeweller.

Investors can redeem digital gold as physical coins and bullion or cash out their investment.

 

Benefits of Investing in Paper Gold

Here are the advantages of investing in paper gold:

•    Gold has long been recognized as the most sought-after and valued precious metal, and its allure continues to grow. 
•    Gold is a hedge against inflation. By purchasing gold today, investors can potentially protect their wealth from the erosive effects of inflation. They can sell it in the future and potentially regain their purchasing power. 
•    Gold maintains its intrinsic value over time. Throughout history, gold has consistently remained in demand, even during times of crisis. This makes it a relatively liquid asset that is easily sold when needed. 
•    Investors can use their paper gold as collateral to secure loans. By pledging their gold, they can access additional funds when required. 
•    Paper gold can be passed on to future generations as a valuable asset. It can serve as a means of preserving wealth and providing a tangible inheritance. 
•    Gold is resistant to depreciation over time, unlike many other assets that may lose value due to wear and tear or technological advancements.
Investing in paper gold offers the potential for long-term value retention, liquidity, and the ability to pass down wealth to future generations.
 

Conclusion

While investing in paper gold in India offers advantages, it is crucial to carefully consider the options before deciding. Sovereign Gold Bonds (SGBs) are well-suited for long-term investors as they mature in the eighth year. On the other hand, Gold ETFs provide better liquidity than SGBs, making them more suitable for those seeking greater flexibility in trading.
Additionally, it is important to consider the taxation aspect of these investment options. The tax implications differ significantly between SGBs and Gold ETFs. Gains realized from the redemption of SGBs are exempt from tax. In contrast, long-term capital gains from Gold ETFs are taxed at 20% after factoring in indexation benefits.
Considering the differences in maturity, liquidity, and taxation, investors should carefully evaluate their investment goals and preferences before deciding between SGBs and Gold ETFs.
 

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