Gold can be a good investment asset to have as part of a balanced portfolio. Gold boasts some of the highest liquidity in the commodity markets and has more often than not increased in value over time. Investors need to have a demat account and a trading account to be able to invest in gold ETFs.
From the time of ancient civilizations to the modern era, gold has been the world’s currency of choice. Today, investors buy gold mainly as a hedge against political unrest and inflation. In addition, many top investment advisors recommend a portfolio allocation in commodities, including gold, in order to lower overall portfolio risk. The opportunities for investing in gold, including bullion (i.e. gold bars), mutual funds, futures, mining companies, and jewelry. With few exceptions, only bullion, futures, and a handful of specialty funds provide a direct investment opportunity in gold. Other investments derive part of their value from other sources.
This is perhaps the best-known form of direct gold ownership. Many people think of gold bullion as the large gold bars held at Fort Knox. Actually, gold bullion is any form of pure, or nearly pure, gold that has been certified for its weight and purity. This includes coins, bars, etc., of any size. A serial number is commonly attached to gold bars as well, for security purposes. While heavy gold bars are an impressive sight, their large size makes them illiquid, and therefore costly to buy and sell.
For decades, large quantities of gold coins have been issued by sovereign governments around the world. The advantages of bullion coins are:
• Their prices are conveniently available in global financial publications.
• Gold coins are often minted in smaller sizes (one ounce or less), making them a more convenient way to invest in gold than the larger bars.
• Reputable dealers can be found with minimal searching, and are located in many large cities.
Caution: Older, rare gold coins have what is known as numismatic or ‘collector’s’ value above and beyond the underlying value of the gold. To invest strictly in gold, focus on widely circulated coins, and leave the rare coins to collectors. Some of the widely circulated gold coins include the South African krugerrand, the U.S. eagle, and the Canadian maple leaf.
Gold ETFs and Mutual Funds
One alternative to a direct purchase of gold bullion is to invest in one of the gold-based exchange-traded funds (ETFs). Each share of these specialized instruments represents a fixed amount of gold, such as one-tenth of an ounce. These funds may be purchased or sold just like stocks, in any brokerage or IRA account. This method is, therefore, easier and more cost-effective than owning bars or coins directly, especially for small investors, as the minimum investment is only the price of a single share of the ETF. The annual average expense ratios of these funds are often around 0.65%, much less than the fees and expenses on many other investments, including most mutual funds.
Some funds invest in the indexes of mining companies, others are tied directly to gold prices, while still others are actively managed. Read their prospectuses for more information. Traditional mutual funds tend to be actively managed, while ETFs adhere to a passive index-tracking strategy, and therefore have lower expense ratios. For the average gold investor, however, mutual funds and ETFs are now generally the easiest and safest way to invest in gold.
Gold Futures and Options
Futures are contracts to buy or sell a given amount of an item, in this case, gold, on a particular date in the future. Futures are traded in contracts, not shares, and represent a predetermined amount of gold. People often use futures because the commissions are very low, and the margin requirements are much lower than with traditional equity investments. Some contracts settle in dollars, while others settle in gold, so investors must pay attention to the contract specifications to avoid having to take delivery of 100 ounces of gold on the settlement date. Options on futures are an alternative to buying a futures contract outright. These give the owner of the option the right to buy the futures contract within a certain time frame, at a preset price. One benefit of an option is that it both leverages your original investment and limits losses to the price paid. A futures contract bought on margin can require more capital than originally invested if losses mount quickly.
About 49% of the global gold production is used to make jewelry.5 With the global population and wealth growing annually, demand for gold used in jewelry production should increase over time. On the other hand, gold jewelry buyers are shown to be somewhat price-sensitive, buying less if the price rises swiftly. Buying jewelry at retail prices involves a substantial markup – up to 400% over the underlying value of the gold. Better jewelry bargains may be found at estate sales and auctions. The advantage of buying jewelry this way is that there is no retail markup; the disadvantage is the time spent searching for valuable pieces. Nonetheless, jewelry ownership provides the most enjoyable way to own gold, even if it is not the most profitable from an investment standpoint. As an art form, gold jewelry is beautiful. As an investment, it is mediocre – unless you are the jeweler.
The Bottom Line
Larger investors wishing to have direct exposure to the price of gold may prefer to invest in gold directly through bullion. There is also a level of comfort found in owning a physical asset instead of simply a piece of paper. The downside is the slight premium to the value of gold paid on the initial purchase, as well as the storage costs. For investors who are a bit more aggressive, futures and options will certainly do the trick. But, buyer beware: these investments are derivatives of gold’s price, and can see sharp moves up and down, especially when done on margin. On the other hand, futures are probably the most efficient way to invest in gold, except for the fact that contracts must be rolled over periodically as they expire.
The idea that jewelry is an investment is storied but naïve. There is too much of a spread between the price of most jewelry and its gold value for it to be considered a true investment. Instead, the average gold investor should consider gold-oriented mutual funds and ETFs, as these securities generally provide the easiest and safest way to invest in gold.