When economic times get tough or the stock market looks jittery, investors often turn to gold as a safe haven. For example, interest in gold surged in early 2020 during the coronavirus crisis and the recession that followed it, as investors looked for a safe asset to park their money.
Savers and investors like gold for many reasons, and it has attributes that make the commodity a good counterpoint to traditional securities such as stocks and bonds. They perceive gold as a store of value, even though it’s an asset that doesn’t produce cash flow. Some see gold as a hedge against inflation, as they worry that the Fed’s actions to stimulate the economy – such as near-zero interest rates – and government spending may send inflation racing higher.
Why investors like gold
“Gold has a proven track record for returns, liquidity, and low correlations, making it a highly effective diversifier,” says Juan Carlos Artigas, director of investment research at the World Gold Council.
These qualities are especially important for investors:
- Returns: Gold has outperformed stocks and bonds over certain stretches, though it doesn’t always beat them.
- Liquidity: If you’re buying certain kinds of gold-based assets, you can readily convert them to cash.
- Low correlations: Gold often performs differently from stocks and bonds, meaning when they go up, gold may go down or vice versa.
In addition, gold also offers potential other advantages:
- Diversification: Because gold is not highly correlated to other assets, it can help diversify portfolios, actually making them less risky.
- Defensive store of value: Investors often retreat to gold when they perceive threats to the economy, making it a defensive investment.
Those are a few of the major benefits of gold, but the investment – like all investments – is not without risks and drawbacks.
While gold performs well sometimes, it’s not always clear when to purchase it. Since gold by itself doesn’t produce cash flow, it’s difficult to determine when it’s cheap. That’s not the case with stocks, where there are clearer signals based on the company’s earnings.
Moreover, because gold doesn’t produce cash flow, in order to make a profit on gold, investors must rely on someone else paying more for the metal than they did. In contrast, owners of a business – such as a gold miner – can profit not only from the rising price of gold but also from the business increasing its earnings. So there are multiple ways to invest and win with gold.
5 ways to buy and sell gold
Here are five different ways to own gold and a look at some of the risks that come with each.
1. Gold bullion
One of the more emotionally satisfying ways to own gold is to purchase it in bars or in coins. You’ll have the satisfaction of looking at it and touching it, but ownership has serious drawbacks, too, if you own more than just a little bit. One of the largest drawbacks is probably the need to safeguard the physical gold and insure it.
To make a profit, owners of physical gold are wholly reliant on the commodity’s price rising, in contrast to owners of a business, where the company can produce more gold and therefore more profit, driving their investment higher.
You can purchase gold bullion in a number of ways: through an online dealer such as APMEX or JM Bullion, or even a local dealer or collector. A pawn shop may also sell gold. Note gold’s spot price as you’re buying, so that you can make a fair deal. You may want to transact in bars rather than coins, because you’ll likely pay a price for a coin’s collector value rather than its gold content.
Risks: The biggest risk is that someone can physically take the gold from you, if you don’t keep your holdings protected. The second-biggest risk occurs if you need to sell your gold. It can be difficult to receive the full market value for your holdings, especially if they’re coins and you need the money quickly. So you may have to settle for selling your holdings for much less than they might otherwise command on a national market.
2. Gold futures
Gold futures are a good way to speculate on the price of gold rising (or falling), and you could even take physical delivery of gold, if you wanted, though that’s not what motivates speculators.
The biggest advantage of using futures to invest in gold is the immense amount of leverage that you can use. In other words, you can own a lot of gold futures for a relatively small sum of money. If gold futures move in the direction you think, you can make a lot of money very quickly.
Risks: The leverage for futures investors cuts both ways, however. If gold moves against you, you’ll be forced to put up substantial sums of money to maintain the contract or otherwise the broker will close the position. So while the futures market allows you to make a lot of money, you can lose it just as quickly.
In general, the futures market is for sophisticated investors, and you’ll need a broker that allows futures trading, and not all of the major brokers provide this service.
3. ETFs that own gold
If you don’t want the hassle of owning physical gold, then a great alternative is to buy an ETF that tracks the commodity. Three of the largest ETFs include SPDR Gold Trust, iShares Gold Trust and Aberdeen Standard Physical Swiss Gold Shares ETF. The goals of ETFs such as these is to match the performance of gold minus the annual expense ratio. The expense ratios on the funds above are only 0.4 percent, 0.25 percent and 0.17 percent, respectively, as of May 2020.
The other big benefit to owning an ETF over bullion is that it’s more readily exchangeable for cash at the market price. You can trade the fund on any day the market is open for the going price. So gold ETFs are more liquid than physical gold, and you can trade them from the comfort of your home.
Risks: ETFs give you exposure to the price of gold, so if it rises or falls, the fund should perform similarly, again minus the cost of the fund itself. Like stocks, gold can be volatile sometimes, too. While these ETFs own physical gold, they allow you to avoid the biggest risk of owning the physical commodity: the illiquidity and difficulty of obtaining full value for your holdings.
4. Mining stocks
Another way to take advantage of rising gold prices is to own the miners who produce the stuff.
In some ways this may be the best alternative for investors, because they can profit in more than one way on gold. First, if gold rises, the miner’s profits rise, too. Second, the miner has the ability to raise production over time, giving a double whammy effect. So you get two ways to win, and that’s better than relying on the rising price of gold alone to buoy your investment.
Risks: If you’re investing in individual stocks, you’ll need to understand the business carefully. There are a number of tremendously risky miners out there, so you’ll want to be careful about selecting a proven player in the industry. It’s probably best to avoid small miners and those that don’t yet have a producing mine. Finally, like all stocks, mining stocks can have volatile prices.
5. ETFs that own mining stocks
Don’t want to dig much into individual gold companies? Then buying an ETF could make a lot of sense. Gold miner ETFs will give you exposure to the biggest gold miners in the market. Since these funds are diversified across this sector, you won’t be hurt much from the underperformance of any single miner.
The larger funds in this sector include VanEck Vectors Gold Miners ETF, VanEck Vectors Junior Gold Miners ETF and iShares MSCI Global Gold Miners ETF. The expense ratios on those funds are 0.52 percent, 0.53 percent and 0.39 percent, respectively, as of May 2020. These funds offer the advantages of owning individual miners with the safety of diversification.
Risks: While the diversified ETF protects you against any one company doing poorly, it won’t protect you against something that affects the whole industry, such as sustained low gold prices. And be careful when you’re selecting your fund: not all funds are created equal. Some funds have established miners, while others have junior miners, which are more risky.
Investing in gold is not for everyone, and some investors stick with placing their bets on cash-flowing businesses rather than have to rely on someone else to pay more for the shiny metal. That’s one reason legendary investors such as Warren Buffett caution against investing in gold and instead advocate buying cash-flowing businesses. Plus, it’s simple to own stocks or funds, and they’re highly liquid, so you can quickly convert your position to cash, if you need to.
Original source: Bankrate