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Physical Gold vs Paper Gold: why is the gold price spread so high?

13:10, 27 May 2020

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Physical Gold vs Paper Gold

There are two options to choose when Investing in gold: physical gold vs paper gold in its multiple variations. But how do you decide which type of gold suits you best? First, find the major reason why you invest in gold.

  • Are you going to speculate on the price of gold going up or down?
  • Are you buying gold to hedge your risks and use it as a wealth protection?

If you want to own gold to protect your funds from inflation and loss of purchasing power, to smooth your returns from other investments such as badly performing stocks, or to diversify and hedge your portfolio during economic and political distress, then physical gold may be your choice – in a long-term perspective.

Physical Gold vs Paper Gold – what should I invest in?

Gold bullion buyers often wonder why the highly volatile gold spot price is usually lower than the price of gold bullion products. Let’s start with two simple definitions:

Physical gold price – refers to a bullion of a fine gold in a coin or bar format.

Gold spot price – the price of gold traded in the financial markets. It is determined by gold futures with the highest trading volume. 

The additional price for buying physical bullion products is associated with manufacturing, refining, minting, marketing and warehousing of the bullions on sale.

Gold shortage: when the price of physical gold decouples from paper gold

Usually, when the financial markets’ environment is calm, the price of physical gold bullion products hover slightly above the fluctuating gold spot price. For example, if the gold spot price is $1,500 an ounce, most gold bullions will be traded just a little bit higher than this figure – less than one per cent above the gold spot price for large gold bullions and a few percentage points for gold coins.

The situation changes during volatile financial markets. In times of significant gold bullion demand, as it happened during the 2008 Financial Crisis, the price for gold bullion products surged significantly higher than the fluctuating gold’s spot prices. 

For example, the world’s most popular gold bullion coin was traded 25 per cent above the gold spot price in the fall of 2008: 1 oz American Gold Eagle Coin was priced $875, when the gold spot price was hovering nearly $700 oz.

Paper gold vs physical gold ratio: how it works

  • Gold futures contract traders buy and sell gold futures on worldwide futures exchanges. Although they often do not physically exchange any real-world commodity, gold futures determine fluctuations in gold spot prices in various fiat currencies, including US dollar gold spot price

  • Gold refiners purify the gold ore into .999 fine bullion or 22k gold planchets and then sell their products to mints and governments. Government gold mints and private gold mints produce gold bullion bars and coins. After that they sell them to gold dealers. Retail and wholesale gold bullion dealers deliver gold bullion products to your door or to professional insured storage facilities at prices over the fluctuating gold spot price.

Physical gold and paper gold price analysis

Recently, we have seen a real disconnect between the spot price of gold on the financial markets and the physical gold market. With gold refineries shutting down in March this year, we saw the price ramp up from about $1,500 an ounce up to $1,660 in a matter of days.

That was a sizable move and it happened because of a disconnect between what was going on in the paper gold vs physical gold investment markets. 

April was also described as a period of high volatility and lack of liquidity. Three major gold refineries in Switzerland got shut down due to the coronavirus lockdown. And it created a problem for the financial markets, or the so-called paper gold. A real disconnect happened, with limited gold bars ready for delivery.

Paper gold vs physical gold ratio

According to the latest gold technical analysis, its price is still moving along a two-month-old upward-sloping channel. Technical indicators on the gold chart are also holding in the bullish territory supporting prospects for a further near-term appreciating move. The latest gold spot price as of May 26, 2020 is hovering around $1,725.

Paper gold vs physical gold ratio

Physical gold or paper gold: choose your own strategy

Let’s take a closer look at the latest gold spot price analysis and news and see how to trade it with CFDs in a highly volatile market environment in a short video by market strategist David Jones.


Physical and paper gold: currency of the last resort

The aftermath of the Covid-19 pandemic may have much longer economic consequences, forcing people to search for a defence strategy. Gold is seen by many as the “currency of the last resort” – some sort of buffer or defence in times of economic turmoil.

Holding gold and cash is considered a proper way to lay a suitable buffer. There are several reasons why investors are bullish on gold, despite high premiums:

  • Virus spread has forced central banks to trim rates and purchase assets in unprecedented amounts. Gold stands from other assets with its ability to preserve value.
  • While some major central banks, including the Fed, use printing machines to replenish money supply, gold preserves precious scarcity.
  • Gold has always served as a preferred hedging tool. The demand for gold significantly increases amid challenging times.
  • Typically, gold has an inverse relation to the US dollar. Softening in USD favourably supports bullion prices.

Read more: Gold price prediction: $2,000 per ounce within 12 months

What You Need to Know

The week ahead update on major market events in your inbox every week. Subscribe
The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
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