[As usual, this is just my opinion, I could be dead wrong about everything and you should consult a licensed financial advisor to see what’s right for your financial circumstances.]
Now what?
There’s the right way and the wrong way to invest in gold. By investing the wrong way, you stand to lose some or all of the benefits that this metal has to offer. So pay attention.
Jewellery: Not a good idea, unless you like jewellery. Essentially, ounce-for-ounce, jewellery prices are marked up significantly from the gold spot price. Plus, the effective bid-ask spread can be quite wide, since you buy at a premium and sell at a discount to someone who plans to melt the metal down for scrap. Also, a lack of standardization can make jewellery transactions time consuming.
A Fund or ETF that Invests in Gold Futures: If you’re trading gold fairly frequently, this is an extremely efficient way to invest in gold. Bid-ask spreads are minimized (provided the fund has enough volume, or a market-maker), contract characteristics are standardized and the funds are fairly liquid. Consequently, these funds tend to replicate the gains/losses in spot gold quite nicely.
But there is a big downside.
Futures contracts are paper contracts based on an underlying asset. For each buyer of a futures contract there is a seller. The contract seller promises to deliver a certain amount of the underlying asset at a certain date, even though the seller may not actually currently own the asset. Most futures contracts are closed out with a cash payment avoiding the logistics of delivery. For this reason, futures contracts work quite well most of the time.
However, because futures contract sellers don’t necessarily own the underlying asset, there could be future contracts on more of the asset than actually physically exists in the world. Researchers suggest this is the case for gold futures.
If a hypothetical event happened where all gold futures buyers demanded physical deliver instead of cash settlement there would not be enough gold in the world to settle the contracts. Two things would happen: 1) contract sellers would rush to the physical gold market to buy gold, driving up the price, and 2) many contract sellers would default on the futures contract. Therefore, while the price of the underlying asset may rise, the buyer of a gold futures contract may experience losses as sellers default. This is a highly unpredictable scenario.
Because of the uncertainty around gold futures contracts, some investment funds choose to instead invest in physical gold bullion. These funds store the bullion in a financial intermediary – such as a bank – and are another easily-accessible, efficient way to own gold. [Beware: there is a difference between ‘allocated’ and ‘unallocated’ bullion. ‘Unallocated’ holdings is simply a claim on a pool of gold, whereas ‘allocated’ bullion is a claim on specific bars with identifying serial numbers. Since there may or may not be enough unallocated gold in the pool to cover all claims, this is similar to owning a fund that invests in gold futures.] Funds that invest in bullion tend to be a little less liquid, with many trading as closed end funds. Closed end funds often trade at a discount or premium to the actual value of their holdings, so one must be wary of the premium they are paying. One way to look at the premium is to compare it to the costs (bid-ask spread, fees, etc.) of personally buying a bar of gold.
Bullion: This leads me to the final way to own gold. In my opinion, this is the best way to own gold. Whether you stuff it in a closet or burying it in the back yard, having some physical gold bullion on hand is a great way to protect your wealth. Buy owning the bullion yourself, you remove yourself from the chain of dependencies involved in owning it through a fund. While funds may be an efficient way to own gold during normal times, when you own gold through a fund, you’re depending on the markets, the safe-keepers, the managers, etc. Will they all come through for you during a crisis? Maybe, maybe not.
If you decide to own bullion, why not store it in a safety deposit box? If the financial system ever collapsed (and this is likely what a gold investor is hedging against), do you think the banks would be open to let you access their vaults? This is why I think it is important to store some at home (in a very secure area).
Personally, I think most people who invest in gold for the long-run could benefit from using a combination of closed end funds that invest in allocated gold bullion and from owning bullion and storing it in an accessible location. [Gold trading is a slightly different story – if you’re trading frequently, the idea of owning physical gold (whether directly or indirectly) may not suit your needs.]
For more information contact your financial advisor.
