Category: 2. How to invest in gold ?

Apart from the demand for gold in nugget form, the metal has significant industrial uses. According to the U.S. Geological Survey, 50% of gold is used in the manufacture of jewelry, 37% in electrical and electronics, 8% for official coins, and 5% for “other” purposes.

One of the biggest sources of gold demand, however, is from global central banks. They have purchased gold bullion in record amounts in recent years, led by Russia and China. Since central banks are the largest holders of gold bullion in the world, their influence on the gold market can’t be overstated.

Some of these central banks are stocking up on gold to reduce their reliance on U.S. dollars as a reserve asset. This trend is expected to continue for the foreseeable future. If so, it will have a positive impact on both demands for gold and its price.

There are several answers as to why gold is valuable. The first is the attractiveness of the metal itself. Pure gold has a brilliant luster to it and is incredibly durable. It doesn’t rust or oxidize the way other metals do, nor is it subject to tarnishing. Those qualities, along with its rarity, make it popular in the production of jewelry, ornamentation, commemorative medals (like in the Olympics), and building decoration.

Gold is no longer priced at a fixed currency amount in each country. The price of gold is set by the London Bullion Market Association (LBMA), which meets twice each day to set the price at which member banks will buy gold bars. The price is determined by the supply and demand of the metal each day. If demand exceeds supply, the price increases. But if supply exceeds demand, it decreases.

However, since gold is an actively traded commodity around the world, the price is negotiated in transactions between individuals and companies. For example, in times of high gold demand, a gold dealer will charge a higher markup on the price of gold than it would when there is less demand.

The answer to this question gets to the root of why anyone would want to invest in gold.

• Since 1970, the price of gold has risen by nearly 4,800%. By contrast, the stock market as measured by the S&P 500 index, opened in 1970 at 90. It currently sits at approximately 3,000, for a cumulative gain of more than 3,300%.
• Regardless of how gold performs during stock market downturns, the price of gold has easily outperformed stocks over the past 50 years.
• During the financial crisis of 2007, the value of stocks as measured by the S&P 500 fell from 1,424 on January 1, 2007, to 1,123 by January 1, 2010. That’s a 21% decline over three calendar years covering the worst of the meltdown.
• But over the same space of time, gold increased from about $630 an ounce on January 1, 2007, to $1,078 by January 1, 2010. This is an increase of 71% over a three-year period compared to a 21% decline in stocks.

However, it’s important to realize that the prices of gold and stocks don’t necessarily move in opposite directions. The price of gold seems more closely correlated with broader global events than it does with the stock market itself.

For example, during the dot-com bust of 2000–20002, the stock market lost more than 40% of its value peak-to-trough. During that same time, the value of gold remained relatively flat, rising just 10%. And during the decade of the 1970s, when inflation wracked the United States, the price of gold increased by more than 1,800%, while stocks remained essentially flat.

On balance, gold seems to be an excellent portfolio choice during turbulent times.

While physical gold can be a way to diversify and can provide you with a solid, tangible asset that might be able to help when times get tough (or if you believe it’s only a matter of time before the U.S. dollar is completely worthless), it’s important to think through your decision.

As with any investment, it’s important to consider the drawbacks associated with investing in physical gold:

— Where Will You Keep It?

If you invest in physical gold, you have to figure out where you’re going to keep it. Do you have a big safe at home where you can stash your collection of gold coins? Perhaps you are keeping your gold in a safe deposit box at the bank. In either case, your gold is vulnerable to theft.

Of course, you might not have the means to store the gold yourself. Some people prefer to use pooled accounts to help them store their physical gold. Your gold is in a vault, and you have either a numbered bar or coin specifically yours (allocated), or you have a record of a sum of gold (unallocated) assigned to you.

In the case of an allocated account, you usually have to pay a storage fee and an insurance fee. With an unallocated account, you don’t have to pay as many fees, but the gold might remain in the name of the company, putting you at risk if the company goes out of business and creditors get the gold.

When you store gold onsite, you have quick access to it, but it might be more vulnerable to disaster and theft. Store it offsite though, and you might not get access to it when you want it.

— What Will You Use It For?

Many people consider gold “pure money.” After all, it’s been used as a medium of exchange for thousands of years. As a result, it’s tempting to purchase physical gold in an effort to protect yourself against economic collapse.

But if there is an economic collapse, who is going to accept your gold as money? If the system breaks down, gold isn’t going to be useful as barter items. You can’t eat gold or use it for clothing or shelter. Who will want to accept your gold and part with survival items? In such situations, gold just isn’t as valuable as you might think.

— Premiums and Taxes

Another issue with physical gold is that you have to consider the premiums and taxes. Usually, you pay a premium when you buy physical gold, meaning it is marked up from the market price.

Premiums are usually less with pooled accounts, but they are still there. This means if the gold loses its value (perhaps it is a bubble that will burst), you not only see that loss, but the premium you paid when buying it will increase your losses.

Realize too, gold is taxed as a collectible by the IRS. Right now, that means you pay a 28% capital gains tax if you decide to sell your gold for a profit. If you purchase gold stocks, though, you pay the “regular” capital gains rate; you don’t have to pay the collectible rate, although you do if you invest in a gold ETF.

Given that gold doesn’t pay dividends or interest and doesn’t perform particularly well during times of prosperity and stability, it’s hard to make a case for holding it as an all-weather investment. But it does have a demonstrated value during times of crisis, as 2020 seems to shape up to be.

Whatever your method for investing in gold, hold your portfolio allocation to a minimum. An allocation of 10% is likely the most you need.

It won’t make you rich — certainly not in the way that stocks can — but it can act as something of portfolio insurance. That’s because gold may come as close to being a countercyclical investment as there is.

Just be careful not to assume there’s anything magical about gold. It’s an ancient monetary asset that has a way of shining brightly at times when more modern financial instruments seem less secure. For that reason, you should think of it primarily as a defensive asset holding and little more.

This is a way to take a position in gold using leverage. It’s an advanced trading technique, so recommended only if you know the gold market well. In a futures contract, you’re making an agreement to either buy or sell a specific amount of gold at a predesignated future date and price.

The value of the contract will fluctuate with the price of gold, and much as is the case with gold ETNs, there’s an excellent chance of losing some or all your investment, particularly because of the leverage factor.

For example, you might enter an option to purchase gold at $1,800 per ounce by September 15. In doing so, you put up only 20% of the cost of the gold in the option. If the price of gold rises 20% above $1,800, you’ll have a 100% profit. But if it falls by 20%, you’ll lose your entire investment.

Gold mining stocks are not a direct investment in gold, but rather in companies that mine gold. They tend to be far less consistent in value than gold bullion itself, in large part because they’re subject to all the other factors that determine the value of any stock.

But gold mining stocks have specific issues that make them even more volatile than most other stocks.

• Mining companies tend to operate in remote and often unstable regions of the world.
• Gold mining itself is capital intensive, and declines in the price of gold can cause a company’s stock to plummet.

For that reason, gold mining stocks are speculations. They’re mostly a play on rising gold prices. But in virtually every other market cycle, they tend to be a poor investment.

If you want to invest in gold mining stocks — and if you do, it should be with a very small slice of your portfolio — a good choice may be to do so through gold mining funds. Two of the most popular are the VanEck Vectors Gold Miners ETF (GDX) and Fidelity Select Gold Portfolio (FSAGX). Each represents a portfolio of gold mining companies. This provides a level of diversification in an otherwise unpredictable industry. If you need a broker, consider using Ally Invest.

There are two types of gold coins you can purchase: bullion coins — which we just discussed — and numismatic (collectible) coins.

Bullion coins are so-called because their value is based entirely upon the metal content of the coin. Numismatic coins may have an equivalent amount of gold, but their value comes primarily from the rarity of the coin itself.

After gold coins became illegal in 1933, the government called in millions of gold coins from circulation and melted them down for bullion storage. As a result, pre-1933 U.S. gold coins — and those of other countries — have become rare. So, their numismatic value has grown. The rarer a coin type is, the more value it has.

For example, an extremely rare gold coin can have a value hundreds of times higher than its bullion value. You can certainly choose to hold gold in a numismatic form. But understand that numismatics are more closely related to art than they are to gold.

Like many people in developing countries, you can also own gold through jewelry. But most jewelry doesn’t have true investment value. First, most jewelry manufactured in the United States is 14 karat. That means the metal is only about 60% gold — the rest is alloys. Second, jewelry has very high fabrication costs. You may pay $1,000 for a piece of jewelry that contains no more than $100 worth of gold.

Buy jewelry if you like the piece. Just don’t view it as an investment.

You can purchase gold bullion in either coin or bar form. In each case, you’ll pay the per-ounce price for gold plus a small markup charged by the seller.

• Bars come in amounts between one gram (approximately 1/31 of an ounce) and 400 ounces. They have a lower markup because there’s no minting involved. Wealthy investors buy larger bars when they don’t want to hold a large number of coins.
• Coins have the advantage of being both recognizable and portable. That will generally make them easier to sell to a private party. The most common bullion coins are the American Eagle, Canadian Maple Leaf, and South African Krugerrand, though, of these three, only the Maple Leaf is pure gold. And there are many other coins available.
• They’re available in one-tenth, one-quarter, one-half, and one-ounce coins. But be aware that the lower denominations cost more on a per-ounce basis than one-ounce coins. Some coins may be alloyed with other metals. But each one-ounce coin contains a full ounce of gold.

You can purchase gold coins through local coin shops or well-established national dealers that handle all types of precious metals, such as Goldline, Blanchard & Company, and McAlvany ICA. You can either take possession of the coins yourself or have them stored by the dealer. If you choose to have them stored, you’ll pay both storage fees and insurance on an annual basis.

Exchange-traded notes (ETNs) are debt instruments tied to an underlying investment. In the case of gold ETNs, the underlying investment is — you guessed it — gold. You’ll hold a note for a specific amount of time, and when it matures, you’ll be paid based on the performance of the underlying gold.

It’s important to understand that gold ETNs are not a direct investment in gold, but rather gold-related instruments. They can be held as either long or short positions and carry the possibility of losing some or all your investment. For that reason, they’re not recommended for anyone who is not intimately familiar with the gold industry.

Examples of gold ETNs include UBS ETRACS CMCI Gold Total Return ETN (UBG) and DB Gold Double Short ETN (DZZ).