Gold has been sought after for its unique blend of near indestructibility, beauty, rarity and because of its status as a means of exchange and universal currency par excellence for centuries.
Empires and nations have sought to possess gold as a medium of international exchange, as a store of wealth and in order to increase and preserve power. Individuals have used gold as a store of wealth and as insurance against the fluctuations and depreciation of paper money and to protect against other macroeconomic and geopolitical risks.
Throughout history, perhaps no other asset in the world has had the universal appeal of gold and this appeal has increased in recent times due to the very significant macroeconomic, geopolitical, monetary and systemic risk facing our modern global financial system and economy.
Successful investing is about the diversification and management of risk. In layman’s terms this means not having all your eggs in one basket. We know from history that markets can and do crash and if you are not properly diversified your nest egg can be severely affected.
So a healthy portfolio will include a wide range of assets including a variety of equities with exposures to different market sectors and regions; a variety of different countries’ bonds of different durations; a diversified property portfolio; a cash component and a 5-15% allocation to gold related investments and gold bullion. In these uncertain times, caution and risk consciousness is crucially important and counterparty and systemic risk should be considered.
The key is to determine what amount of each asset class to have and to own assets that will whether the onslaught of inflation, deflation, stagflation and even hyperinflation.
Some exposure to gold should be included in all diversified portfolios. A good rule of thumb would be a minimum allocation of around 10% to gold and related gold-investments.
One’s motivation for buying gold is fundamental to deciding in which form you should buy it. Are you a speculator, investor or saver? Do you wish to take a short term speculative position in gold? Are you investing for the short, medium or long term? Or are you diversifying, saving or using gold as a form of financial insurance?
Investing in physical gold
Physical gold should form a part of a properly diversified portfolio. Gold remains a universal finite currency, held by every central bank of note in the world. And central banks are set to become net buyers of gold in 2009 for the first time since 1988. The Indian Central Bank’s purchase of 200 tonnes of gold from the IMF in October 2009 ( and a further 200 tonnes is being acquired) is the biggest single central bank purchase in such a short period of time (at least known to the markets) for at least 30 years.
In the same way that the family home should not be regarded as an investment, gold bullion is not an investment per se, rather a form of ‘saving for a rainy day’ or of financial insurance. It is to be taken possession of or stored with a secure third party and should not be traded. One does not trade an insurance policy and thus as a form of financial insurance, physical gold should not be traded.
Gold is money and is the ultimate safe haven asset and a great way, if not the best way, of ensuring wealth preservation and for passing wealth from one generation to the next. Once the solid base or core holding of gold bullion is achieved in a portfolio then other investments in gold such as mining stocks and mutual funds and other more speculative gold investments can be considered.
Modern bullion coins and bars
Modern bullion coins allow investors to own investment grade gold (between 0.90 and 0.9999 fineness) legal tender coins at a small premium to the spot price of gold as quoted on the markets. The value of bullion coins and bars is determined almost solely by the price of gold and thus follows the bullion price. Larger bars are not generally taken delivery of due to the cost of insured delivery and the security implications of having very large amounts of bullion outside the chain of integrity (say in a private residence). A London Good Delivery Bar weighs 400 troy ounces and costs over $400,000, £270,000 and €300,000 (prices as of 20/11/09) and is prohibitive in terms of cost and thus big bars are normally the preserve of large companies, institutions and central banks.
Gold, silver, and platinum are all available in the form of bullion coins, minted in the UK, the US, in Canada, South Africa, Austria, Australia, China and other countries. Most bullion coins are minted in 1/10oz, 1/4oz, 1/2oz & 1oz form (and some can be bought in 2oz, 10oz & 1 kilo). However, one ounce gold bullion coins such as Krugerrands or Britannias are by far the most popular for both small investors and high net worth individuals who see the advantages of owning legal tender bullion coins, either in their possession or in depositories, and recognise the advantages of the divisibility afforded by them.
Buying investment grade gold bullion for investment is stamp duty free and tax free (VAT exempt) in the UK and EU due to the EU Gold Directive of 2000.
For free and impartial information on where and how to buy gold bullion coins and bars, see MoneyWeek’s comparison of leading gold brokers.
Semi-numismatic and numismatic gold coins
Numismatic or older and rare coins are bought not solely for their precious metal content but also for their rarity and their historical, aesthetic appeal. They are leveraged to the gold price which means that the price of these coins will generally surpass and increase faster than the gold price in a bull market (due to their historical and aesthetic value and to their rarity) and will decrease by more when gold is in a bear market.
The British Gold Sovereign (originally the one pound coin) is the most widely traded and owned semi-numismatic gold coin in the world. Important is the fact that, unlike the other forms of gold investment, British gold sovereigns are not subject to capital gains tax (CGT). Thus all post-1837 British gold sovereigns – because they are legal tender and have a legal tender face value – are capital gains tax free, which is obviously a significant benefit to investors vis-à-vis other gold investments.
Also highly owned are high-quality pre-1933 gold coins graded MS-65 or better by either the Professional Coin Grading Service or the Numismatic Guaranty Corporation. They are bought by both collectors and investors and most opt to take possession of these older coins unless they have invested in significant quantities.
Insured delivery of bullion and numismatics is usually some 1%-2% of the total value. Insured storage of bullion and numismatic coins in an allocated account will cost some 1% per annum. Investors should choose their storage provider carefully, making sure of a high credit rating and high net worth. This leads some to prefer an offshore bank or specialist depository.
For free and impartial information on where and how to buy gold bullion coins and bars, see MoneyWeek’s comparison of leading gold brokers.
The Perth Mint Certificate Programme is the only government backed precious metal certificate programme in the world. It allows investors to own bullion in unallocated or allocated accounts. The Perth Mint retains its AAA credit rating from Standard and Poor’s and Moody’s and is one of the safest and securest ways to own investment grade gold bullion. There are no initial or ongoing shipping, insurance, holding or custodial fees and thus it is one of the most cost effective ways for investors to own bullion over the long term.
Gold certificates are liquid and can be sold easily (soon investors will be able to buy and sell in real time online). Most investors opt to own their bullion in unallocated accounts as there are no insurance or holding fees on them and there is the flexibility of being able to transfer to an allocated account simply by paying small fabrication fees should the investor deem it necessary. Every gold bar is audited and accounted for and it is thus considered a safe way to own bullion. Bullion in a format of your choosing (coins or bars) can be shipped internationally from an allocated account or from an unallocated account once it has been converted to allocated.
Allocated gold accounts allow an investor to buy gold coins and bars from a bullion brokerage which will transfer or ship the bullion to an individual’s account in a depository or bank. Allocated accounts involve ownership of specific gold and the owner has title to the individual coins or bars. Due diligence should be done on allocated gold account providers and the history, security, credit rating and net worth of the provider is of vital importance.
Providers: GoldCore, specialist depositories
Digital gold currency or e-gold
Digital Gold Currency, goldgrammes or e-gold are also increasingly popular. There are no specific financial regulations governing DGC providers, so they operate under self-regulation. DGC providers are not banks and therefore do not need to comply with bank regulations and there are concerns that there are unscrupulous operators operating in this emerging sector.
However, two of the more respected providers who have rightly garnered trust are Bullion Vault and Gold Money. They offer allocated accounts where gold can be instantly bought or sold just like any foreign currency. Every gold bar is audited and accounted for and it is thus considered a safe way to own bullion. Digital gold is primarily used by clients to buy gold for saving or as an investment and/ or as electronic money amongst users.
Providers: Gold Money, Bullion Vault
Gold bullion in SIPPs
UK citizens can as of April 2006 invest in gold bullion through their Self-Invested Personal Pensions (Sipps). US citizens could already do so in their Individual Retirement Accounts (IRA’s). Sipps are new types of personal pension scheme that hold investments until you retire and start to draw a pension income. They are designed for people who want to manage their own fund by investing in asset classes of their choice. Investments made in gold bullion are topped up in the form of tax relief, meaning individuals can claim up to 40% back depending on the income tax band they fall in to.
Gold bullion is allowed in a Sipp providing it is investment grade gold which is gold of a purity not less than 995 thousandths or 99.5% pure and which is in the form of a bar, or of a wafer, of a weight accepted by the bullion markets. The bullion must be immoveable and stored with a secure third party. It cannot be taken possession of and used as a “pride in possession” article. Thus ETFs, some digital gold providers, allocated gold accounts and gold certificates are all allowed in the new SIPP.
Providers: GoldCore, Bullion Vault
Investing in paper gold
Mineral exploration, mining and the processes used to mine and produce metals are highly technical. Investors in gold production and exploration company stocks need to equip themselves with a basic understanding of the industry, in order to identify possible pitfalls and the risk-reward relationships of entering this investment sector. Investors should generally not buy just one or two stocks, but rather a basket of unhedged stocks or a mutual fund.
Derivatives, such as ETFs, forwards, futures, options and spread betting are normally short term speculations on the future price of gold and other markets such as commodities, shares or bonds, interest rates, exchange rates, or indices. They are financial instruments which derive their value from or whose price is dependent on the underlying asset. One does not directly own the underlying asset and one does not have a right to take possession of the underlying asset. Leverage or borrowing substantially may increase investment gains but also increases risk as if the price goes against the purchaser they may be subject to a margin call. There is significant leverage involved with derivatives and they are thus considered risky for non professionals as the potential positive or negative outcome is greatly magnified.
Gold exchange traded funds (ETFs)
The recently launched ETFs are derivatives that track the price of gold and silver. Two of the more popular are the Streettracks Gold Shares (NYSE:GLD) and in London, ETF Securities’ Gold Bullion Securities (LSE:GBS). They can be bought through stockbrokers.
There is an annual administration fee of between 0.4% and 0.5% per annum. Thus every year the amount of gold or silver backing an ETF share shrinks by that amount. This makes them unattractive as a medium or long term way to invest in gold. They are akin to derivative contracts that track the gold price and one does not own or have title to the underlying asset. Thus they are primarily used by day traders, hedge funds and institutional players going long and short and speculating on short term movements in the gold price.
Providers: Stock Brokers, Online Brokers
Gold stocks are not gold – rather they are shares in gold mining companies. If the gold price rises, profits of a gold mining company should rise and as a result the share price should rise. There are many factors to take into account and it is not always the case that a share price will rise when the gold price increases. It is important to consider the performance and abilities of the management, auditors and geologists; the conduct of trade unions; a company’s gold hedging position; whether it is producing or exploring; its cost basis; how much reserves it has in the ground and whether it is subject to political, economic, nationalisation or environmental risk.
Individual gold shares would be regarded as very volatile and high risk. Gold shares are regarded as more speculative as there is a higher risk-reward scenario. However, the added risk can be compensated for by the leverage which can result in higher returns. Such higher returns would be expected from mid and large-capitalisation un-hedged senior gold mining companies with proven reserves and strong earnings which have strong balance sheets and growth in resources and production and effective company management.
Providers: Stock Brokers, Online Brokers
Gold stock options
Stock options are a contract between two parties that expires at an agreed-upon time in the future. The contract purchaser is buying the right, but not the obligation, to buy a gold mining stock (a ‘call’ option) or sell (a ‘put’ option) a gold mining stock (the ‘underlying’) at a specific price, on or before the agreed-upon date, the date of expiration.
Stock options allow for a lot of leverage as a trader can control a large stock position with only a small outlay. However due to the very short term of the option contracts, they can expire worthless with the entire outlay being lost. Stock options allow speculators to make bets on market movement without having to pick an up or down direction. Because of this, stock options traders are often said to be trading volatility rather than price.
Providers: Online option brokers such as Options Express and E-Trade and certain stockbrokers
Precious metal unit trusts or mutual funds
Instead of personally selecting individual shares, some investors spread their risk by investing in collective investment vehicles specialising in investing in the shares of gold mining companies. These include mutual funds, open-ended investment companies (OEICs), closed-end funds, unit trusts. Two of these funds are the UK-based Blackrock Gold & General Fund and the Canadian Sprott Gold & Precious Minerals Fund by Sprott Asset Management. There are many precious metal funds in the US but investors assume US dollar currency risk when buying them.
Collective investment vehicles are a good way to invest in the precious metal mining sector as an investor’s risk is reduced; mutual funds are not dependent on the performance and profits of one or two individual gold mining company and specialists in the field choose a portfolio of gold mining companies.
Providers: Blackrock Gold and General Fund, Sprott Gold & Precious Minerals Fund
Gold futures are traded on exchanges in London, Tokyo, Sydney, Singapore, at the New York Mercantile Comex Exchange (COMEX), the New York Mercantile Exchange (NYMEX) and at the precious metals department of the Chicago Board of Trade (CBOT).
Gold futures contracts are firm commitments to make or take delivery of a specified quantity and quality of gold on a prescribed date at an agreed price. Investors may take or make delivery of the gold underlying the contract on its maturity although, in practice, that is unusual. A benefit for some is that such contracts are traded on margin, so that only a fraction of the value of the contract has to be paid up front. As a result an investment in a futures contract, whether from the long or the short side, tends to be highly geared to the price of bullion and consequently more volatile.
They are normally the preserve of some mining companies, speculators, hedge funds and institutions. The leverage makes them a high risk/high reward investment. Participants are either hedging the gold price or attempting to predict whether the value of gold will rise or fall in the short term. Gold futures contracts are valuable trading tools for commercial producers and users of the metal to hedge their price risk.
Success depends on the price movement of gold during the contract term. Traders in these markets without protective stop-losses can quickly find themselves on the wrong side of a fast moving trade, losing large sums of money. Part of the risk is due to the leverage involved which can result in a speculator losing more than their initial capital outlay. Therefore, futures markets are not for amateurs or novice investors.
Providers: Commodity Brokerages, Online Brokerages such as Internaxx
Gold futures options
All the bullion banks trade in gold options and a list of bullion banks is available from the London Bullion Market Association (LBMA). Another way of trading options is through the COMEX Division of the New York Mercantile Exchange. The third route would be to contact a futures broker. They are often used to contain risk in the trading of futures.
Providers: Commodity Brokerages, Online Brokerages
An alternative is to use spread betting to gain leveraged exposure to precious metals. Firms such as Cantor Index, CMC Markets and IG Index offer the ability to take a bet on the price of gold through what is known as a spread bet.
No commissions or taxes are levied in the UK on spread betting. The advantages are that any gains are CGT free and one can also take a view on movements in either direction. The downside is that in a spread bet the spread can be high, your exposure is geared up and short term bets are risky as it is extremely difficult to forecast any markets short term movement. One can lose more than the initial capital thus they are for speculators with very short term horizons rather than investors.
The World Gold Council is a good resource for investors looking for established and reputable providers of gold related investments in the UK and internationally.
Assessing your options
One’s motivation for investing in gold is fundamental to deciding how to invest. Are you a speculator, investor or saver? Do you wish to take a short term speculative position in gold? Are you investing for the short, medium or long term? Or are you diversifying; saving or using gold as a form of financial insurance (gold’s primary role)?
When assessing one’s gold investment options one must decide what one’s motivation is. Once this is done, the primary considerations which should be looked at are the costs (both upfront and possibly recurring annual fees), proximity to your asset and perhaps most importantly today counter party risk.
In the table below we have looked at the various vehicles for accessing the gold market and graded them with regard to cost, ability to take delivery and, most importantly, proximity to your gold and counter party risk.
|Initial||Recurring||Counter party risks||Proximity||Investor suitability||Physical delivery?|
|Gold certificates||Med||V good(none)||Low||Good||Diversifier||Yes||Consider solvency & credit rating. A sovereign AAA credit rating and govt. guarantee is best.|
|Bullion bars/coins delivered||Med||V good (none)||Low||V good||Diversifier||Yes||Use safety deposit boxes, home or office safes, and insurance.|
|Bullion bars/coins stored||Med||Med||Low||Good||Diversifier||Yes||Consider the solvency and credit rating of the depository. Safety and security are key.|
|Gold bullion in SIPPS||Low||Low||Low||Good||Diversifier||No||Make sure you get impartial fee-based asset allocation advice.|
|Semi numis matics||High||Low||Low||Good||Diversifier/
|Yes||Premiums can vary. Get reputable and professional advice before purchasing.|
|Some do||Concerns over dependence on technology (internet, website, servers, etc) which is attendant risks.|
|Exchange traded funds||Low||High||Med||Poor||Speculator||Large minimum||Suitable for speculators, own shares in a trust and not gold. Annual costs quite high at 0.5% per year.|
|Precious metal unit trusts||Med||High||Med||Poor||Diversifier/
|No||High annual charges (funds can have hidden charges). Analyse the prospectus fully.|
|Gold stocks||Low||Low||High||Poor||Speculator||No||Very volatile. Management, geologist, auditor, trade union, environmental and nationalisation risk. Seek advice.|
|Gold futures||Low||Med||High||Poor||Speculator||Yes||Only suitable for speculators. High risk, involving leverage. Seek advice.|
|Spread betting||Med||Med||High||Poor||Speculator||No||Only suitable for speculators. High risk, involving leverage. Need to monitor trading constantly. Seek advice.|
In an age of significant systemic risk, proximity to the underlying asset is increasingly important. Investors are increasingly wary of having too many counter parties (brokerages, banks, trustees, custodians, sub-custodians, delegates of sub-custodians etc.) between them and their asset. If storing gold with a third party, it is important that you have a direct relationship with that counterparty and there is not significant intermediation and thus increased risk. Another consideration is the ability to take delivery of gold in the event of a systemic crisis.
Investing in gold: conclusion
As we have seen, there are major differences in the various motivations for buying gold and ways to buy gold – from trading and speculating to investing and saving.
Holding precious metals in a portfolio can provide distinct benefits in the form of speculative gains, investment gains, hedging against macroeconomic and geopolitical risk and / or wealth preservation. Traditional asset allocation theory, as represented by the investment pyramid, advocates higher risk speculations at the top, with lower risk assets at the bottom. Commodity futures contracts, options and exploration junior mining companies should be placed at the top of the pyramid, while cash equivalents and fully allocated or taken delivery of physical bullion should form the foundation or base.
Experienced and knowledgeable investors have long known that gold and gold related investments can be solid investment choices. Gold is stable in times of global geopolitical instability and when there is economic uncertainty, recessions and depressions. It is important that investors look at their portfolios holistically. Used correctly, gold and gold related investments can be highly effective components of a properly diversified investment portfolio.
• This article was written by Mark O’Byrne, executive director of international bullion dealer GoldCore. GoldCore has an international media profile (CNBC, Bloomberg, CNN, BBC, FT, Wall Street Journal, Bloomberg, Dow Jones, Associated Press, Reuters etc.) and takes part in the Reuters Precious Metals Poll and the Bloomberg Gold Survey.
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