Your Guide to Investing in Gold

Friday, July 31, 2020 8:04 AM | Nick Dey

The price of gold has risen sharply recently as investors worry about a recession caused by the coronavirus and inflation caused by government spending to fight the recession.

Investors regularly flock to gold, and other safe-haven investments, during periods of economic uncertainty as a way to escape the volatility in stocks and other assets. Safe-haven investments are typically things that not positively correlated to the stock market, meaning they can actually increase in value during market distress. This includes cash, stocks in defensive sectors, government bonds, and some commodity-linked securities.

Gold is among the longest-standing safe-haven investment. Some of this dates to a time when money was made of gold, and then later when paper money was exchangeable for a fixed-amount of gold. The reason gold persists as investment is because of the same properties that once made it useful as money. It is relatively rare, hard to to imitate and doesn't have a lot of special or expensive storage requirements. This means the supply stays pretty constant, and the cost of ownership is extremely low so it doesn't serve as a drag on your portfolio.

Gold's role as a stable store of value works in both directions. It does well when the prices of other assets are falling, but it tends to underperform when other assets' prices are rising.  Gold's position as a store of value doesn't just apply to changes in the price of financial assets, it also applies to the price of money.

Inflation is really just a decline in the value of a currency. This is the reason many investors buy gold, as either a hedge against, or a bet on, inflation. If you convert dollars into gold and the dollar loses value, converting your gold back into dollars will bring you more dollars than you put in.

Changes in the conversion rate between dollars and gold is the only way to make money buying the shiny metal. Gold doesn't pay interest or a dividend. It isn't a business, so it can't grow organically either. This is why gold can be a drag on a portfolio when the economy is good.

Gold tends to perform best when investors are worried about not just the economy, but the value of currencies. Government bonds are incredibly safe in terms of giving you a return on the amount of currency you invested, but if the value of the currency declines significantly, the money you get back from bond will be worth less than your initial investment.

There are lots of ways to add gold to your portfolio, each has advantages and drawbacks.

Gold:

You can buy gold bars or bullion. This is maybe the easiest way to own gold, it is just a big piece of metal you can keep somewhere safe. There two major problems with owning physical gold. First, there is a mark up to buy gold from what is known as the spot price, which is the price quoted in financial media as the price of gold. Meanwhile, it is rare to be able to sell gold for the spot price or higher. This is not a problem if you expect a big change in the price of gold over your holding period, but trying to sell a very large amount of gold to your local gold dealer is likely not going to get you the best price. The other problem is safety. Keeping a large amount of gold in your house is potentially risky, but paying for extra home security or paying your to store your gold somewhere else adds costs, ultimately cutting into your return.

Gold Coins:

Gold coins have many of the same issues as gold bars, but there is an added complication to owning coins. If you're looking to buy gold coins because you want to own gold, you don't want to accidentally get caught up in the market for collectible coins. Investors will want to be sure they are buying non-numismatic coins to avoid paying a premium for highly sought after coins.

Gold Futures:

Futures are are contracts  to buy or sell an asset at a future date. Futures allow commodity producers to lock in a price for their product in advance. Futures are also tradeable, so you can buy and sell futures with no intention of actually buying or selling gold, so long you either close your position before the contract expires, or trade contracts that are settled in cash. You can bet on the price of gold to go up or down with futures. The downside is that futures expire, making them unsuitable for a long-term investment as a hedge against in.

Gold ETFs:

Gold exchange-traded funds (ETFs) another way to get exposure to gold without owning the metal yourself. Gold ETFs, the ones are track the daily price movement in gold, and not some multiple of it anyway, are backed by stores of physical gold in a warehouse. Doing the buying and selling at scale on the global gold market cuts down on the pricing issues with buying physical gold and the expiration issues that come with futures. Scale also makes the security costs for any individual investor relatively small.

Gold Miner Stocks:

Another way to get exposure to gold is to own shares in companies that mine gold. These stocks tend to be pretty strongly correlated with the price of gold, in the same way that oil company stocks tend to move up and down with the price of oil. The potential issues here are related to owning a stake in a company, and not actual gold. The prices are correlated, but aren't necessarily tied together. Gold mining is increasingly a dangerous and expensive process as humans have scooped most of the easy-to-find gold already. This means that in addition to changes in the price of a commodity, investors are adding a bunch of other, unrelated risks to their portfolios. A lot of gold is produced in politically unstable parts of the world. Political turmoil and labor strife can interrupt the work at mines, causing drops in the earnings, and share prices, of individual companies. These companies are also exposed to environmental risks and mine collapses, floods and other problems can also interrupt production.

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