When it comes to investing in gold there are a number of different ways in which you can participate in the underlying movements of the infamous yellow metal. However, not all gold investments are created equal, and if you choose the wrong type you can end up with a seriously underperforming asset -- even if the price of gold moves in your favor.
Gold, unlike almost any other investment product, has the ability to daze and confuse otherwise level-headed investors, causing them to risk their money in ways they wouldn’t normally. Much of this is due to the fact that gold has a historical narrative that incites emotions in us; emotions which can get in the way of sound financial judgment.
For example, telemarketer’s use those emotions when they pitch the idea of investing in gold to unsuspecting victims, reminding them that empires were built on gold and how the fiat currency of the United States will become worthless after the coming zombie apocalypse.
But gold should be looked with the same care and consideration you give any of your financial decisions, so let’s take a look at some of options available for investing in gold and which ones make the most sense.
Traditionally this is the most common and straightforward way of investing in gold. Simply buy coins or bars from an online dealers, or your local coin shop, and then put them away for safe-keeping. Unfortunately, buying the physical metal is also the most inefficient way to own gold.
Mark-ups and commissions on physical gold sales can be very high and depending on what state you are in you may have to pay sales tax on the purchase as well. More inefficiencies come up when you go to sell your gold since the IRS considers gold bullion and coins “collectables” which are subject to a higher maximum tax rate of 28%.
Storage of physical gold is also a problem. Do you really want to store your gold at your home where it may be at risk of theft, fire, or natural disasters? Some companies will offer to store your gold for you and you can always get a safe-deposit box at the bank, but in both these scenarios you will be charged a fee and may not be able to access your gold if you need to sell it on short notice.
When investing in gold via futures or with options, you are in essence using leverage to control a larger amount of the commodity than you could with just the money you are putting at risk. This is a very efficient way to play gold and offers you the ability to profit on price moves, either up or down, depending on whether you are bullish or bearish on the market.
The downside to this method is that derivative contracts are highly volatile and incorporate complex concepts like time decay value and seasonality into their price, which increases your risk. And although the leverage they offer can turn a small amount of money into a big profit, the converse is also true; you can lose your total investment very quickly.
Gold Mining Stocks
Gold mining companies come in two different sizes – junior and major. Junior miners are companies that are newer or more speculative, often mining unproven claims hoping to find a big score. Major miners are more established companies with established production, mining on proven and sustainable claims. There are a number of both junior and major mining companies that are public which allow you to buy their stock.
The theory behind buying mining stocks is that as the price of gold goes up, the profit margins of the companies go up as well, which should be reflected in their stock prices. But the problem with this type of investment is that you are not purely investing in gold, but the companies that mine gold, which can be problematic.
Just like any business, if a mining company is not run efficiently due to poor management, the price of their shares will suffer even if gold moves up in value. They also have to contend with other issues unrelated to the price of gold. Often their production comes out of mines based in foreign countries which are susceptible to natural disasters, changing political climates, and labor strikes.
Exchange Traded Funds
For the vast majority of investors, an exchange traded fund, or ETF, will be the smartest and most efficient way to invest in gold.
The most popular gold ETF is the SPDR Gold Trust, with the symbol GLD, and one share is roughly equal to 1/10th of an ounce of the spot price of gold.
There is also the Market Vectors Gold Miners ETF, with the symbol GDX, which tracks major miners as well as the Market Vectors Junior Gold Miners ETF, with the symbol GDXJ, which as the name implies, tracks junior miners.
The advantages you get with GLD are numerous. It accurately tracks the movement of gold, has low expenses, eliminates storage issues, and trades in one of the most liquid environments in the world, allowing you to sell it instantly whenever the stock market is open.
The mining ETF’s help to eliminate the issues related to putting all your money in one company specific basket. Though GDX and GDXJ will not always track the price of gold as accurately as GLD, by being a proxy for the mining industry as a whole, they spread the risk across multiple companies.