How to Invest in Gold

GoldShould You Invest in Gold?

Uncle Joe is new to investing. He hears that the international markets are in trouble. Everybody keeps telling him not to invest in the markets until the turbulence settles. His biggest fear is losing all of his money to a bank run, should the American economy collapse. While he’s weighing all his options, his old friend introduces him to gold investing. Uncle Joe is all ears.

What ensues hereafter is an intro in how to invest in gold—Gold Investing 101—for Uncle Joe and all my readers who share his dilemma.

The world is going through rough times. The second episode of the Chinese stock market crash last week has spooked stock investors across the globe. Meanwhile, bond yield spreads are rising, adding to investors’ fears of bigger defaults in the bond markets.

At the same time, leaving cash idle in the bank isn’t earning savers a penny. With interest rates under one percent and inflation close to two percent, investors who are stashing cash stand to lose all of its worth in real terms.

In times like these, bullion becomes the next best alternative for investment.

Bullion investing is basically gaining financial exposure to precious metals—primarily, gold, silver, platinum, and palladium. Of these, gold offers the most liquidity.

From an investment perspective, here are some ways through which one could gain exposure to gold, both directly and indirectly.

1. Physical Gold

The simplest and most direct form of gold investing is in spot gold, that is, you buy gold jewelry, gold bars, or gold coins—jewelry from a jewelry store, bars from a bank or a dealer, and coins from a dealer.

Coins are the most commonly held form of physical gold, after, of course, jewelry. The best options are the American Eagle, American Buffalo, and Canadian Gold Maple Leaf coins.

When looking for a coin dealer, always seek one who offers the best bargain value. Albeit small, dealers charge premiums on coins above the spot gold price, meaning that you’ll be buying these coins at a price higher than the current market price of gold. In order for you to make money on your investment, the spot price of gold must increase enough to cover the premium you paid. This is why you should look for a dealer who is selling coins for the lowest premium.

2. Gold ETFs

If you don’t want to buy physical gold, you may gain indirect exposure to gold through exchange-traded funds (ETFs). In fact, billionaire hedge fund managers George Soros and David Einhorn both hold gold ETFs instead of physical gold in their portfolios.

ETFs indirectly track the price of a basket of assets. Gold ETFs, in particular, come in three forms: 1) those backed by physical gold, meaning they track gold’s spot price; 2) those backed by gold miners’ stocks, such that they track the stock prices of a handful of prominent gold mining companies; and 3) those backed by gold futures, meaning they track the prices of derivative contracts that speculate the future price of gold.

The simplest of all these—and the relatively better-performing option—are the gold ETFs backed by gold. The most popular physically backed gold ETF is SPDR Gold Shares (NYSEArca:GLD), followed by Physical Swiss Gold (NYSE:SGOL) and iShares Gold Trust (NYSE:IAU).

Before investing in gold ETFs, though, two things must always be considered. Firstly, actively managed ETFs charge a nominal management fee that varies from fund to fund. Before making up your mind on buying into an ETF, don’t forget to compare the management fees.

Secondly, ETFs may trade at a discount or a premium to their net asset value (NAV), which depicts the market value of net assets held by that fund. Ideally, you want to buy an ETF that’s trading at a discount to its NAV, since the one trading at a premium is most certainly overvalued.

3. Gold Stocks

The third possible way to add gold to your investment portfolio is to buy gold stocks. By “gold stocks,” I mean companies that are involved in the mining, exploration, development, and production of gold.

Famous gold mining stocks to consider include Randgold Resources Ltd. (NASDAQ:GOLD), Barrick Gold Corp. (NYSE:ABX), AngloGold Ashanti Ltd. (NYSE:AU), and Newmont Mining Corp. (NYSE:NEM), to name a few.

The risk involved here is that like any other listed company, gold stocks are exposed to stock market fluctuations. The same rules of investment will apply here that apply to any stock on the stock market, in that you’ll have to weigh the financials and fundamentals before jumping into any of these stocks.

4. Gold Derivatives

Finally, gold options and gold futures contracts are an indirect way to invest in gold—albeit, a very risky one. This is why I saved this option for the end of my list. Gold derivatives should be the last investment resort for any novice investor.

Unlike the spot gold market, where the prices are listed as they are, the futures market trades contracts on future price speculations. Because of the risks involved and the level of sophistication required, investors should strike this option off their radar if they’re not a seasoned trader.

To wrap it all up, gold derivatives, gold stocks, and gold ETFs that are not physically backed by gold are some of the riskier investments. On the other end of the risk spectrum, there’s physical gold and gold-backed ETFs, which are relatively simpler, safer investments.

Since Uncle Joe is at level one of gold investing, he should consider physical gold or a basic ETF that is backed by gold for his investment portfolio, at least until he earns enough experience points to move to level two.

Tune in to Profit Confidential’s gold feed every week for more on gold.