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How to invest in gold

March 2nd, 2016 by ,    photos by

Use it as a safe haven if you must, but never speculate


Over the past month or so, the price of gold has climbed steadily, gaining nearly US$150 per ounce, to around a recent US$1,240 per ounce. This is the biggest sustained gain in the past 12 months. Does it now make sense to shift a portion of your asset allocation to gold? And if so, with all the vehicles now available, which would be the best way to invest?

It’s true that gold does tend to be a kind of “fear barometer.” But it’s a volatile one, and its predictive value is questionable. Still, it’s been long considered a “safe haven” store of value when financial conditions deteriorate badly. Banking troubles, serious geopolitical crises, and runaway inflation are some of the main drivers behind sharp increases in the price of gold, as traders abandon more conventional assets like equities, bonds, and currencies for the perceived safety of gold as a stable store of value. Fundamentally, gold continues to be in demand both for jewelry and industrial applications, and these factors also tend to influence the price of gold, albeit on a cyclical basis.

What’s behind the run into gold?

The first few months of the year did indeed see the rise of some of the macroeconomic conditions that frequently see a rush to safe haven assets. In the U.S., the Federal Reserve Board held off increasing interest rates, citing uncertain economic conditions, as the price of crude oil plumbed new lows, manufacturing contracted, China wrestled with a strong yuan and deteriorating growth, and Europe faced renewed financial and political stresses in the face of a seemingly unstoppable flow of migrants from war-torn North Africa and the Middle East.

Global stock markets plunged into bear market territory as a result, and bond yields retreated as hot money flowed into fixed income, pushing prices up (bond prices and yields move inversely). As central banks’ conventional tools of stimulus seem to be wearing out, they are increasingly either floating the idea of, or actually implementing (for example, in the case of Japan and the European Central Bank), negative interest rates in an effort to stimulate lending and thereby spur growth. But negative rates weigh on bank profits, raising investor concerns about the stability of banks and the banking system in general, especially in stressed environments, such as the eurozone. Hence, the stock market meltdown through January was led not so much by the energy sector as by the banking and related financial sectors.

Stocks have rallied somewhat recently from their 52-week lows, but volatility continues to be the watchword. The CBOE Volatility Index (VIX) hovers around 21 after reaching a high of around 30 this past month. That’s an indication that investors are willing to pay a larger premium for stock options as insurance, but it’s nowhere close to the intraday high of 53 that the VIX touched last August.

Safe haven appeal

Against this backdrop, the price of gold has climbed steadily as nervous traders rediscover its “safe haven” appeal. If you’re truly nervous about global business and financial conditions, it doesn’t hurt to have a small allocation to gold as a cushion against troubled times. But bear in mind that gold is a non-productive asset – it has no yield and produces no income. The only growth available is through capital gain, and that depends entirely on the vagaries of the commodity markets. Essentially, when you buy gold in the hopes of selling it later at a profit, you are speculating, not investing. And speculators acknowledge that they can enjoy strong gains but also suffer steep losses very quickly.

There are a number of ways to buy gold:

Bullion, certificates, and coins. You can purchase the physical commodity as wafers, bullion bars, or coins, and lock them up in your safety deposit box. It’s the most straightforward way of buying gold. But you will incur safe-keeping costs, and in the case of coins, you’ll pay a hefty numismatic premium. Some dealers also offer gold-bullion certificates, which are essentially a claim on a specified amount of gold (usually a minimum 5-oz. bar) held in the institution’s vaults. If purchasing a certificate, make sure it’s from a large, reputable financial institution, usually a bank.

Gold funds. You can purchase units of an exchange-traded fund (ETF) that holds nothing but gold bullion. In effect, your ETF unit represents a share of the physical gold bullion that the fund has a claim on either through physical holdings in a warehouse or in certificates it has purchased or some combination. In Canada, the iShares Gold Bullion ETF (TSX: CGL) is one such fund, while Central Fund of Canada (TSX: CEF.A) is a closed-end physical-gold fund that’s been around for 55 years. The U.S.-based SPDR Gold Shares (NYSE: GLD) is the granddaddy of gold ETFs, and the largest physically-backed gold ETF in the world, holding some 711 tonnes of gold worth about US$27.7 billion at recent prices. With their low MERs, ETFs are the most economical way to hold physical gold if you don’t want the hassle of buying the stuff directly from a dealer yourself, and most investors go this route.

Some mutual funds also invest in physical gold, but such funds typically also hold at least some gold-mining equities, and so cannot be considered a pure gold holding.

Options and futures. Of all the ways to stake a claim on gold, these are the riskiest. Options and futures contracts represent in interest in a specified amount of gold at a specified price and time. These types of instruments, called derivatives, carry the very high risk of 100 percent loss of your stake. They are for expert commodity traders and speculators only, and I recommend all others avoid them.

Getting a second opinion

It’s always prudent to talk to a qualified financial advisor when considering revisions to your portfolio or to your overall asset allocation strategy, just to make sure you’re not simply reacting to the fear headlines of the day and that you’re fully aware of the impact that asset changes will have on your long-term financial plan.

Note: Securities mentioned are not guaranteed and carry risk of loss. This article is for information only, and is not intended as personal investment advice. Always read the prospectus before investing. Consult a qualified financial advisor before making investment decisions.

Jul 26 2017 7:33pm

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