The allure of gold is not difficult to understand.
It’s shiny and heavy… and when you touch it, it feels valuable.
But is buying gold for investment purposes worthwhile? After all, you can’t live in it or eat it.
In most circumstances, you can’t directly buy anything with it either.
In this article, we’ll look at:
- The two ways to classify gold.
- Different ways to invest in gold.
- When to invest in gold.
- The disadvantages of investing in gold.
Commodity or Money
On the surface of it, gold is a commodity. It is a physical metal that gets mined out of the earth. You can hold it, wear it and get some industrial use out of it.
But that is one of the odd things about it.
Unlike, silver or copper or palladium, it doesn’t have that many industrial applications. Demand for gold is not driven by industry.
So, what dictates its price?
Well, most people treat it like money. And if most people treat it like money, then to some extent it IS money.
If enough people believe it is a store of value and have faith in it, then it is basically money.
This is because over the thousands of years of financial history, it is only until very very recently, that gold has not been used as a means of exchange.
For millennia, it served extremely well as currency, and the collective human conscience still remembers and recognises this. It also shows an innate, and perhaps unconscious, distrust of paper money.
Buying Gold for Investment Purposes
1. Physical Gold
If you have ever had much contact with gold, you’ll understand how hypnotic it can be. There’s just something about the solidity of it that is extremely reassuring.
It stands to reason that many people want to be able to actually hold their gold… and no doubt look at it lovingly every once in a while!
The best way to invest in physical gold is either coins or bars.
Different countries mint different coins.
Although they will weigh a certain exact amount (and so technically should be consistently valued), some coins are more desirable then others depending on your location. Do your research as to what coins you can buy and how easy they will be to sell… in whatever location you’re in… when the time comes.
This goes for bars as well.
People do have their preferred makers, so do your homework.
Bars come in a variety of weights from very small up to the 400-ounce “Good Delivery” bars that are the ones traded by major dealers, including central banks.
The obvious major issue in investing your money in gold bars and coins is storage (see below). There are also tax issues to consider when buying and selling gold, depending on what country you reside in.
Some people might like to invest in gold jewelry. I think this is mostly dependent on culture.
In some Asian cultures gold chains etc. are bought and sold as a commodity. There are buy and sell prices and dealers make money from the spread.
In western cultures, normally they types of jewelry that most people buy cannot be traded in such a liquid market. Therefore, for investment purposes, it is not recommended.
2. Gold Investment Funds
There are a lot of financial products that allow you to invest in gold, without actually having the headache of protecting your stash of the yellow metal.
At exchanges the world over you can buy into funds that hold securities that relate to gold.
The easiest way to invest in gold is using an ETF. It will tracks the price and can be bought and sold freely on the stock market.
Some ETFs claim to actually buy and store the gold. This kind of product means you do not have to look after the gold yourself. And you have access to a liquid market should you decide to sell.
There are skeptics that say that some funds in fact do NOT hold the physical gold. Or that they only have a fraction of it. It’s difficult to know whether these claims are true or not.
Who do we believe?
How can you trust anyone when you are buying something remotely online?
3. Gold Mining Stocks
There are a lot of companies whose stock price is linked to the price of gold. If you own mining stocks they may also pay a dividend, which is something that the physical metal does not do.
Gold mining stocks are leveraged to the gold price, so can potentially bring you much bigger gains.
As a hypothetical example, say a gold mine can get gold out of the ground profitably when the price is $1000.
If the price goes up to $1500, then that extra $500 is mostly profit. The companies earnings per share increase, and the stock price gets re-rated upwards accordingly.
However, gold is often mined in politically sensitive places and so you need to do your research on where the company’s reserves are. You have to look at the risk of government interference in its operations.
There is nothing that will send a mining stock down as quick as rumblings about nationalization.
When is Gold a Good Investment?
Common wisdom says that the price of gold goes up when inflation is high… and down when inflation is low. Therefore to many investors, one of the major benefits of investing in gold is that it’s a hedge against inflation.
In reality, it might not be inflation per se that dictates the rise in the price of gold. It actually seems that it goes up at times when people distrust central banks.
Those times might correlate with times of high inflation… but it may not be the cause.
Many people will tell you to have a certain portion of your portfolio in gold to protect you against such times. I’ve heard five or ten percent mentioned. Maybe not entirely in gold but in other precious metals, too.
Gold also makes up 25% of the permanent portfolio. This weighting strategy is a simple hands off mechanical way to manage your assets.
On the surface it seems like a massive amount to have. If you are at all concerned about the disadvantages of gold as an investment, then this might be a little to much for you to handle.
Disadvantages of Investing in Gold
Lack of Yield
A major disadvantage of investing in gold is that it doesn’t yield anything.
It is not a productive asset, therefore it cannot throw off a dividend like a lot of other asset classes.
If you invest in a company that pays a dividend then your money is working for you. You get to own some of the company and as a reward, it will pay you some money.
Even if the stock goes down in value, you can still receive a dividend (provided the company stays solvent).
With gold you don’t get that benefit. If the price goes down, you have to suck it up. And with reinvested dividends contributing massively to the final value of investments over the long-term, gold might seem like a silly thing to hold.
Also, holding the physical metal requires adequate storage and insurance.
Nice as it is to hold the stuff, you are going to need somewhere safe to store it. If this is at your home you should really get a safe of some kind.
- Do you have a safe?
- Is it possible to install one in your home?
- How much is it going to cost to insure your gold?
Then you have to think about who knows that you hold physical gold? You could become a target for thieves if somehow they found out about your stash.
There are many banks and safety deposit box establishments that will store your gold for you. But storage costs money and without an increase in price you will be looking at a loss.
A New Gold Standard
One way that would see the gold price shoot up dramatically, is if there were a return to any kind of a gold standard.
If central banks agreed to once again use gold as backing for the world’s money supply, then it would involve a huge upward adjustment in the price. Most mainstream financial commentators think this is unlikely, though.
It would require an unprecedented amount of international cooperation for that to happen, which makes it doubtful. With the size and diversity of the global economy, it would need all the big players on board to make it work.
It’s true that the financial system is in need of overhauling. But currently, central banks can print unlimited amounts of money to stop the system from collapsing. They have done it before.
(Witness what has happened since the Great Financial Crisis. The Bank of Japan has been at it for even longer.)
When they have this power, then they can devalue their currencies as and when they like. With a gold standard they couldn’t… and I don’t think they are willing to give up that power.
Having said that it could be smart to invest in gold as most central banks still hold some.
Why do they need to do that if the age of gold as money is over?
Some say the Chinese central bank is buying gold on the quiet… and they are manipulated the price lower. They say it is stocking up in preparation for when the US dollar falls from its position as the go to reserve currency of the global financial system.
Let’s Stay Calm
With talk of the fall of the dollar we are drifting into murky water.
We could even be talking conspiracy theories.
And that is where a lot of people who doggedly believe in the strong future performance of gold as an asset class spend a lot of their time.
Search around investing forums and you will come across people nicknamed “gold bugs”.
They are constantly talking up precious metals and will use every opportunity to turn a thread into a list of reasons why you should buy gold.
They often justify their claims by referring to the fragility of our current financial system. And the fact that governments keep bailing it out.
And if you think about it, if society does collapse, and our paper money system goes out the window, will we start using gold?
I doubt it.
If that time comes, then people will be far more concerned about basic survival than trading using gold.
Guns and food would be far more desirable.
What are your thoughts on gold? Do you have any gold investments? Do you own any other precious metals? Please leave your comments below.