Gold Investing

Throughout history, humans have had a primal attraction toward gold. From the gold in the tombs of Egyptian Pharaohs to pirate gold bullion treasure, investors and wealth seekers have, in one way or another, always been interested in gold investing.
Modern investors attracted to gold are varied; some see it as a store of value against poor government economic management and inflation, while others, such as gold bugs, are convinced that it will keep increasing in value over time and believe everyone should hold some. What is clear is that gold is not going away soon, and this may trigger in increased interest on your behalf.

What Is Gold Investing?

Gold is a precious metal which is considered an asset due to the value ascribed to it by the financial community. This value is derived by its shiny appearance and consequent use in jewelry. Furthermore as it is a hard asset which is less affected by physical damage than other assets (such as a bank note which can be torn, burnt or put through the washing machine by mistake!). It is also hard and expensive to manufacture.

Gold’s historical importance

The Bentton Woods system was a monetary system that created rules that Western governments should follow in relation to their exchange rates. Central to this was the obligation to tie the value of their currency to gold. This created a system, known as the gold standard, where exchange rates were ‘controlled’ by the price of gold, which was seen as a stable asset.

Eventually, this system was abandoned due to the limitations it placed on expansive economic policies and the volatility of the price of gold. In particular, the gold standard stopped governments from borrowing money, such as creating a quantitative easing program. There were also concerns about the fluctuation of the price of gold. Yet the discipline the gold standard forced on governments highlighted how gold is the asset of choice when it comes to trusting that an asset will keep some form of value.

Do not write gold off yet

Interestingly, despite the gold standard no longer being a requirement today, many countries still hold large quantities of gold. France and Italy each hold just under 2,500 metric tonnes of gold. This is driven by a desire to have their financial reserves in an asset, other than the US dollar. The US government is the largest holder of gold in the world with just over 8,100 metric tonnes.

The UK only holds 310 metric tonnes after selling a large part of their holdings between 1999 and 2002. It is often considered to have been a bad decision. Large newly developing economies such as China and India have been big buyers in recent years, reinforcing the importance attached to gold.

The more things change, the more they stay the same

Gold is seen as attractive by governments for similar reasons to investors, it is not directly controlled by anyone. Two of the safest assets in the world today are controlled by the US government (The US dollar and Treasury Bonds). Gold is therefore seen as an alternative safe asset.

In the 21st century, governments have increasingly turned to printing money as the solution to an economic crisis (news traders could have anticipated this financial crisis and may have positioned themselves accordingly). This means that the prices of traditional assets such as stocks and bonds are being held up by government intervention. Although the gold price will have benefited from these government interventions, as it is a tangible asset (unlike the others), investors have greater confidence in it.

A store of value or growth asset?

All these reasons mean it is seen as store of value because whatever its price, physical gold will always have a value. Interestingly gold is actually considered as a currency within the financial asset community. Gold is closely linked to the US dollar due to the former gold standard. As a result, the gold price tends to trend up with the US dollar and vice versa.

Due to the importance ascribed to gold, investors are confident there will always be a market for it. Yet the dynamics of gold investing are different from other asset classes. Unlike bonds where the coupon provides a return or equities where the share price (should in theory) grow as the profits grow, the gold price has no clear driver. Indeed many see it as a store of value, not a growth asset.

What Is the Aim of Gold Investing?

There are two distinct aims, one is capital preservation, the other is diversification.

Capital preservation

Gold in its physical form is considered indestructible. Theoretically the only way to get rid of it, is to melt it. As a result, despite its movement in price, it will always have a ‘commodity’ value.

Conservative investors

Some investors are risk adverse. They want assets which will always keep their value. US government bonds and the US dollar are seen as among the safest assets but both are subject to control from politicians. Gold is  not ‘controlled’ by any government.

It’s price is subject to what others will pay for it. As many people see it as a store of value, it can be argued, it’s price will be supported by (many) investors who feel the same.

Maintaining purchasing power

Swiss private banks are known to be conservative investors of their private client’s money. Risk management is often at the forefront of their decisions. As a result they seek a risk-adjusted return, and one of these risks is inflation. This will lead them to invest in assets which are deemed to offer inflation protection, such as gold.

If the price of items which are important to you, such as food and medicines, are rising then without a pay increase you are in effect getting poorer. Investing in assets which appreciate with inflation is one way of protecting your ability to purchase the items you need, without increasing the percentage of your budget which goes towards it. It should be noted that it is not universally agreed that gold gives inflation protection.

Diversification of assets (including holding physical as opposed to technological gold)

Who knows what tomorrow will bring. The 21st century stock market only seems to go up, which means to buy the dip makes you money every time. Yet at some point a genuine economic recession will arrive. Investors will rush for the exits, creating a market correction. If all your money is in hot stocks such as Tesla, Then a sudden and violent sell off could be very painful.

Holding some of your stock portfolio in gold means some of your assets will hold their value. It is also worth having a little of everything in case an asset class suddenly becomes in vogue. You do not want to be the one who buys in after the main move has happened.

In the March 2020 Coronavirus-caused sell-off, gold also sold off in price. This was peculiar. Gold is traditionally seen as a safe heaven. This occured because many investors were leveraged up to their eyeballs. As assets sold off violently, the only asset which had not lost considerable value was gold. This led to gold positions being liquidated to meet margin calls. For those seeking capital preservation, gold many no longer offer the diversification it once did.

The Different Mechanisms of Gold Investing

Jewelry

When Jewelry is spoken about, people often focus on diamonds, without realising that the gold which often makes part of the jewelry piece has value in itself. This value will derive from the purity of the gold which is derived from the number of carat. 24 carat gold is considered pure gold. Note for men looking to ‘invest’ in a marriage, check the number of carat in the gold which makes up the engagement ring. Women notice this!

Jewelry is therefore a form of investment, in that over time gold’s value tends to appreciate or at the very least keep some form of value. Jewelry is also easily transportable but on the downside, theft if a risk, just ask Tamara Ecclestone who had £25m stolen from her. This can also affect businesses as was the case with the Hatton Gardens safe deposit box robbery.

Smaller jewelry

You do not have to buy expensive pieces of gold jewelry to invest in gold. Another option is to buy gold coins. Indeed coin collecting enthusiasts will learn that part of the value of old coins is the metal they were made with. Gold coins have the advantage of being easily transportable, even if everyone does not realise this…

During WW2, a girl always wondered why every time there was an air raid, her mother took a particular tin box of sweets with her to the cellar. She found out after the war that it contained among the sweets, gold coins!

Buy gold through a professional dealer

If you wanted to buy gold in the UK, you would often go through a London dealer. The focus on London is because 3 of most secure gold vaults are located there. They are the Bank Of England, JP Morgan and HSBC. If you are buying gold in large quantities one of the issues you have, is storing it somewhere safe. As a result of the above, London is a good location. Another location would be Swiss banks in Geneva where there is a long history of gold being stored.

Buy and ETF

With investing for beginners having taken off, many novice investors use online platforms to invest in passive investments. These offer the chance to buy an Exchange Traded Funds (ETFs) which tracks the price of gold. Especially for those are only looking to trade gold, they are an easy way of moving in and out of gold.

You should be aware that ETFs do carry some risks, especially one which uses derivatives to gain exposure to an asset. This was highlighted when a derivtaive based ETF for another popular asset class nearly imploded,

For conservative investors who wish to invest in gold through an ETF, ensure that it is backed by physically-held gold. This means that the value of the ETF will be driven by the market price of the total amount of gold is has deposited, rather than than derivative contract which could go very wrong.

Digital gold

For those of you who like to be at the forefront of technology but still have safety in mind, then digigold is for you. This is offered by The Royal Mint which is owned by the UK government. It allows you to buy gold ‘online’ safe in the knowledge that this holding backed by a physical gold bar.

The Pros and Cons of Physical Gold vs an ETF

Pros

Holding physical gold is something which will always have value and not subject to being electronically hacked or lost. You can also transport small smalls around with you (such a gold coin) to barter with in an end-of-the-world situation. An example would be for a loaf of bread or a boat to ‘get out of dodge’.

Holding gold through an ETF is cheap and ideal if you intend to trade it. As a store of value, it is ideal if there is a sudden bout of volatility in markets. You can easily sell your gold ETF to buy up risky assets whose sell off in price may have produced a buy opportunity.

Cons

Physical gold is heavy and difficult to keep in large quantities in your home. It can easily be stolen. Storing it in a vault is expensive and the fees will rack up over time. You may also have a small issue with subsidence… Large quantities of gold are heavy and left pilled up to the ceiling will do your buildings foundations little good!

An ETF giving you exposure to gold may defy the point of holding gold. Gold is seen as a safe asset which will keep its value. Therefore if you hold it within a vehicle which relies on your broker’s computer and reconciling system, how can you be sure where it is?

Alternative Gold Investing Strategies

We have already covered the mainstream ones such as buying physical gold or through an ETF, but there are other ways to gain exposure to gold.

Buy gold miners

Companies such as Newmont and Barrick Gold are among the largest gold mining companies in the world. They are both listed for those wishing to invest in them. You should be warned that as they are equities, they are likely to be much more volatile than the gold price. You are also at the risk of poor management, creative accounting and other company specific problems.

Trade gold using derivatives

This is a high risk strategy and should only be attempted by experienced investors with a high risk tolerance. This strategy involves using derivatives, such as futures trading, to bet on the price of gold. Derivatives often involves leverage, which means you can lose more than you put in. Trading the gold price in this way can sometimes mean losing sense of what is actually driving the gold price.

Gold receipts

These are proof of ownership of gold which can be redeemed at a future date for gold. Although no longer possible to get these from governments, it is still possible from some private mints such as the Royal Canadian Mint. They offer electronic tradable receipts (ETRs) which is backed by gold stored in a fault.

Gold Funds

If you are already investing gold directly through different strategies, then their will be some overlap with a gold fund. The gold fund manager will likely be buying the same items as you. The advantage of a gold fund is having a professional who is able to buy gold when it dips below a certain price. This is appealing if you do not have the time or inclination to watch the gold price closely.

What Are the Risks With Gold Investing?

Inflation hedge myth

It is unclear if gold is a true source of inflation protection. Quite frankly the data is not supportive. As a result you should see it more as an outright store of value than an inflation specific one.

Cost of holding it

Nothing is free in life, but gold requires a vault or some other kind of secure location to hold it. There are plenty of vaults, but these will charge you for the pleasure. As gold does not yield anything, this cost will have to be met by you or yield from another of your investments.

Jewelry demand drops

One of the key drivers of the gold price is demand for jewelry. A genuine recession, such as the world has not had since 2008, could lead to a drop in jewelry sales. At the very time where you expect your (gold) asset to hold up in value, is the very time it will loose value!

The Alternatives to Gold Investing

When choosing whether an investment is attractive for you, it is always useful to consider the alternatives. This gives you a wider view as to whether something is worthwhile. Below are some alternatives to gold investing:

Silver

Silver is arguably more useful than gold because it is a component in more items than gold and is more affordable. As a result industry depends more on silver, which makes it more liquid, i.e. easier to sell. The liquidity of your asset(s) i.e. ability to turn it into cash should not be ignored. As a minus it is considerably more volatile than gold.

Real Estate

Buildings have the same attraction as gold in that they are permanent and a tangible asset. They are also easier to protect, no-one is going to do a runner with your house on their back, but are harder to sell on account of the time a transaction can take. Real estate investing also requires considerable capital which is often beyond many investors.

Private Equity

PE as it is known for short has become increasing fashionable as an area to invest in. This is due to many high growth companies choosing to stay privately owned longer than usual. Historically a company would list as soon as possible. Today the only way to gain access to these higher growth companies is through funding rounds which often Private Equity often has access to.

Conclusion

Gold is virtually indestructible. Its permanence is what makes it interesting to investors. It is not an asset which is expected to appreciate incredibly. It is an asset for those who seek a return with less risk. Let’s be clear though, gold investing does carry risks. None-more-so than the belief that it is a perfect hedge for inflation.

Indeed the true price of gold is less clear than other assets. It has competing forces which affect its price, such as businesses, speculators and those seeking to protect their capital. Yet, the importance attached to gold means it will always have buyers, this in turn should ensure it is a store of value for years to come.

Gold Investing FAQs

How does the expense ratio factor into the returns from gold investing?

The expense ratio of an investment in gold, like that of the SPDR Gold Trust (GLD), plays a vital role in shaping your returns. This ratio represents the proportion of fund assets spent on management, administrative, and other expenses. 

As these costs are drawn from the fund’s assets, they may decrease overall returns. Therefore, it’s crucial to take the expense ratio into account while aligning your investment decisions with your financial objectives. A seasoned financial advisor can provide valuable insights into this matter.

Why should one consider gold as an investment strategy?

Gold, typically represented on Wall Street by the ticker ‘GLD’, offers a means to diversify your investment portfolio. This precious metal is frequently considered a ‘safe haven’ during economic turbulence. 

Moreover, it provides a hedge against inflation and currency volatility, notably against the USD. Given the individual nature of investment strategies, it’s highly recommended to consult with a financial advisor for personalized advice before venturing into gold investing.

What is the nature of SPDR Gold Trust (GLD), and how has it performed historically?

The SPDR Gold Trust is an exchange-traded fund (ETF) that aims to reflect the performance of the spot price of gold. This ETF allows investors to access the gold market via a security traded on a regulated stock exchange. With its assets backed by physical gold stored in London, each GLD share signifies a portion of a troy ounce of gold. Please note, while the GLD’s historical performance has typically mirrored that of the spot price of gold, the past performance doesn’t guarantee future outcomes, as detailed in the ETF’s disclaimer.

How do gold investments respond to changes in interest rates and the USD?

The performance of gold investments is significantly influenced by interest rate fluctuations and the strength of the USD. High-interest rates often lead to decreased gold prices as investors seek yield-bearing assets. 

On the other hand, when interest rates drop, gold prices often surge. Similarly, the strength of the USD impacts gold prices. A weak USD makes gold more affordable for those holding other currencies, which can boost demand and increase prices. Keeping an eye on these variables and other economic indicators such as cash flow, and referring to reliable sources like Bloomberg and the World Gold Council, can help investors make informed decisions.

How do gold investments stack up against palladium and cryptocurrencies?

Investment in gold, palladium, or cryptocurrencies each carry unique features. Gold has long been regarded as a stable asset and an effective inflation hedge. 

Palladium, a rare metal with significant industrial applications, sees its price influenced by supply-demand dynamics in the industrial segment. 

Cryptocurrencies, like Bitcoin, represent digital assets that rely on cryptographic security, known for their volatility and potential high returns. To invest in these, a brokerage account is required, and your investment choices should align with your financial goals and risk tolerance. While gold offers stability, cryptocurrencies and palladium can offer high returns albeit at a higher risk. It is always wise to seek professional financial advice before making such decisions.

Is Gold investing a good idea?

There is no simple answer to this question. If you are looking to grow your assets, gold will not be the most suitable assets. There are other assets which over the long-term (5 years+) which will outperform. If you are a conservative investor or are looking to diversify your portfolio into something less risky, then gold investing could be for you.

Why is gold so valuable?

Because it is a hard asset and the attraction/importance that we, humans, attach to it. Fundamentally an asset has value if someone is prepared to buy it off you. Gold appeals to different people, those seeking safety (it is hard to physically destroy it), those seeking to preserve wealth (it is seen as a store of value) and those who fear political interference (it is not controlled by any one government).

Will gold protect you against inflation?

It is not clear that it will. This is not to say that it will not, but it is not expressly proven to protect you against inflation. Partly this is because there are other factors which affect its price which are not related to inflation. In an inflationary period, tangible goods typically increase in value due to their being a finite amount. (Inflation occurs when too much money chases too few goods).