Gold: to have or to hold?

By Maike Currie, 21 December 2009

Should you buy gold in its physical form or a financial product that's linked to it? It's an important issue, as it could influence – among other things – the return you make, the risks you run and how much tax you pay.

Coining it

For those that like the security of having something in their possession, gold coins may seem the obvious choice. If coins are bought purely as an investment, there is no income as such derived and therefore no income tax to pay. There is also no capital gains tax (CGT) payable when a UK resident sells UK Sovereigns and Britannia coins for a profit, as these coins are classified as legal tender and are therefore exempt.

According to Physical Gold, a leading supplier of gold coins, buying gold in physical form further enhances returns because you don’t have to share anything with the Inland Revenue.

But while sovereigns might be an enticing investment given the tax advantages, it is important to remember that gold does not have to be in your personal custody to be held physically.

All bar none

Holding gold at home, be it Krugerrands or small gold bars, does raise certain challenges. Unless stored in recognised bullion vaults, gold loses its guaranteed acceptance as 'good delivery' and cannot easily be sold at full price. The London Bullion Market Association (LBMA) only deals in 'good delivery' bars that carry the guarantee of at least 99.5 per cent purity. If you're not trading these, you are effectively excluded from the market.

There are also significant shipping, handling and insurance costs attached to keeping gold tucked away in your safe at home.

A gold bullion exchange such as BullionVault enables you to own physical gold within the reliable 'good delivery' vault system, where the gold is automatically accepted by a professional buyer because it has always stayed in official facilities. Each bar has the assay marks and the paperwork to prove its provenance.

"The professional market knows these bars could not have been corrupted and, in any event, they have a permanent guarantee from the original provider of the bar – so it’s the only way you can get a permanent guarantee of your gold's quality. Of course, once the bars leave the vaulting circuit, any guarantee dies," says Paul Tustain, founder of BullionVault.

Gold-leafed paper

Financial instruments that track gold are gaining in popularity among investors. For example, ETF Securities offers a range of exchange-traded commodities (ETCs) that are gold trackers which trade on the London stock exchange. These notes are physically backed by the actual metal, unlike exchange-traded funds (ETFs) which track a collection of several different commodities.

An ETC such as ETF Securities' Physical Gold tracks the spot price of gold, less the management fee, and has the physical backing of the yellow metal. According to ETF Securities, the gold bars backing these products adhere to the LBMA standard.

The bullion is held by HSBC, which acts as the custodian for approximately 80 per cent of all physically-backed ETCs globally. It is held in the allocated form: uniquely identifiable bars that cannot be lent out, with the vaults subject to independent audits twice a year. No ETCs can be issued until bullion is delivered to the custodian.

Tightly spread

Whether you buy bullion via an online exchange, or track the gold price via an ETC, you can rest assured that your investment is backed by the physical metal in adherence to the standards set out by the professional bullion market. But how do trade spreads compare?

If you are buying gold coins, the chances are that your investment will trade at either a slight premium or discount to net asset value.

In BullionVault's case, the gold is bought and sold directly between private investors who quote their own dealing prices on a public order board that functions like a stock exchange for privately-owned 'good delivery' gold. Competition between users determines the dealing price which stays close to the world spot price.

"With 15,000 users dealing in open and fair competition, the spreads are tiny and many private customers quote prices – so they actually earn the spread rather than pay it – just like a market maker at the stock exchange," explains Mr Tustain.

Typically, digital gold currencies charge no commission but trading spreads are around 2.7 per cent for an investment of up to £60,000. BullionVault, however, charges commission but boasts an average trading spread of zero.

Physically-backed ETCs also boast tight spreads as these vehicles track the spot price of gold. Any changes in the daily price of the yellow metal will match the daily change in the ETC's price, less the management fee.

Of course, another advantage of an ETC is its liquidity. Because they are traded on the London Stock Exchange, these products can be traded and settled just like stocks.

The short and leveraged gold products offered by ETF Securities are priced off the DJ-UBS Gold Sub-Index, which in turn is priced off the Comex gold futures.

Costs & taxes

Keeping gold at home can be an expensive mistake, as the insurance premium is many times higher than it is for storage in a professional vault. By contrast, if you're holding bullion via an online exchange or tracking the price of gold via a physically-backed tracker, your insurance costs are covered.

Storage and insurance fees are included in the management charge of physical-backed ETCs, which is typically around 0.4 per cent. BullionVault has a custody charge of 0.12 per cent a year, subject to a $4 per month minimum. The company also charges a buying and selling commission, which starts at 0.8 per cent and falls progressively to 0.02 per cent, depending upon how much gold you trade each year.

As for tax, gold coins do not attract CGT and are also exempt from VAT. Still, investors need to be wary of the trading costs charged by the coin dealer.

"Sovereigns are very expensive to trade by comparison with bullion – especially when bought directly from the Mint," says Mr Tustain.

If you buy gold via an online exchange it will be subject to CGT – but remember that you have an allowance of £10,100 a year anyway. It is also possible to shield gold bullion from tax charges by holding it in your self-invested personal pension (Sipp).

Gold ETCs have the advantage of not being subject to stamp duty. In addition, the share-like structure of these products allows them to be added to you individual savings accounts (Isa), although it is advisable to check with your Isa provider first.

ETF Securities says that physically-backed gold ETCs have no credit risk, are backed by allocated gold bars stored in vaults, trade and settle like stocks, and ultimately provide investors with a secure, safe and convenient way to hold gold.

On the other hand, Mr Tustain of BullionVault asks whether there is a need to make something as simple as gold into a complicated instrument such as an ETC.

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