2022.05.02
Although gold offers neither a yield (bonds, GICs) nor a dividend (stocks and mutual funds), it is considered a smart investment when inflation diminishes an investor’s principal or erodes the purchasing power of a currency.
Owning gold (and silver) continues to be the best defense against inflation, stagflation, and rampant currency debasement, during this period of unprecedented and irresponsible debt accumulation.
Yet the question often comes up, what is the best way to invest in gold? Is it better to buy coins and bars, or an ETF? What about gold stocks? Gold mining companies have high market capitalizations and steady cash flow from production, yet their growth potential may be limited. Junior gold explorers offer tons of upside but they can be risky.
Below we outline five ways to leverage a climbing gold price.
1. Physical gold. There are several options if an investor goes the route of buying gold bullion. Small bars and coins typically account for about two-thirds of annual “investment gold” demand. According to the World Gold Council, demand for bars and coins has quadrupled since the early 2000s.
For the retail investor, coins are available in denominations of 1/20, 1/10, ¼, ½ and one troy ounce. Bars can be purchased in 1, 10, 20, 50, 100, and 1,000-gram denominations as well as 1, 10, and 100 troy ounces.
Examples of popular investment gold coins are the South African Krugerrand, the American Eagle and the Royal Canadian Mint’s Pure Gold Coin.
The purity of each coin, or fineness, is measured either in carats (24 carats being the highest) or in parts per thousand, usually 995, 999 or 999.5. Investors are usually most interested in products that are 0.999 fine. Another option is to purchase gold rounds which are similar to coins but are not legal tender. In the United Kingdom, gold coins are popular because they are not subject to tax.
The choice of coins versus bars depends mostly on how divisible the investors wants the gold to be. Coins can be collected and sold in very small denominations, versus bars, which are less divisible.
Whether buying a coin or a bar, investors pay a premium over the spot gold price. Generally the smaller the coin or bar, the larger the premium per ounce. Investors would be wise to buy their bullion products from a bank or reputable dealer.
Buyers are provided with a certificate of authenticity, via an assay mark, and have the option of either storing their gold at a secure facility, for an annual fee, or arranging for it to be sent home for safekeeping.
Purchasing gold jewelry is another way to invest in physical gold, although it is often less lucrative than bars and coins. This is because buying jewelry at retail prices involves a substantial markup — up to 400% above the underlying value of the gold. It is therefore recommended that fans of gold jewelry search for their favorite pieces at estate sales and auctions, where there is no retail markup.
2. ETFs. Historically the only way for investors to buy gold was to purchase gold coins or bars, but since 2004 gold, silver, platinum and palladium ETFs have offered a more convenient way to invest in precious metals. The largest gold ETF is SPDR Gold Shares (GLD), which currently has a market cap of $68 billion. The convenience of buying “paper gold” through ETFs, however, has some serious drawbacks, especially in the event of a financial meltdown like 2008 or 2020. The biggest downside is that unless you have 100,000 GLD shares, you cannot take physical delivery of your gold; rather, the shares will be settled in cash.
The other problem is potential breaks in the chain of custody. When you buy shares in a gold ETF, the purchase is through an Authorized Participant, usually a large financial institution. If a primary reason in buying gold is as insurance against a financial calamity i.e. banking system collapse, an ETF really fails to offer any guarantee that your GLD shares would be safe if the bank were to fold.
3. Gold miners. Buying the shares of a large gold mining company could prove successful if the purchase is made at the beginning of a gold bull market. As the gold price rises, gold miner stocks often follow, although this isn’t always the case. If stock analysts don’t like a company’s financials, its sales or acquisition decisions, the quality of its management team, or the future production prospectors, investors may punish its stock price.
The largest gold mining companies have extensive global operations, often with more than one commodity. If the price of gold falls, they can shift their focus to another metal. Some gold producers lower their risk by hedging, which involves forward selling future gold production at a fixed price to lock in guaranteed revenue, rather than taking their chances with the spot price if it falls.
This allows them to show a profit even in times of flat or declining gold prices.
4. Junior gold stocks. Historically, junior gold stocks offer the best leverage to a rising gold price because of the huge opportunity for gains. Say you like Barrick right now so you buy 500 shares at C$28/sh – a $14,000 investment. Barrick has a good first half and the stock price goes to $35. You think that’s a pretty good deal so you sell it, pocketing $7 a share. Your $14,000 has turned into $17,500, a 25% gain.
Option two: You find out about a junior exploration company that has a very good project in a safe jurisdiction, with experienced management, lots of cash and plenty of exploration upside. The company is trading at $0.23 a share. You only have $7K to spend so you buy 30,400 shares.
About five weeks into a drill program your junior hits a discovery hole. The share price triples to $0.69. You’re smart enough to take the profit, so you sell. Your $7,000 is now worth just under $21,000.
How likely is it that a major gold company like Barrick would triple in six months? The odds are set pretty high against you. What are the odds of a gold junior tripling in six months? Reasonably good.
Of course you have to weigh the potential gains against a possible loss. While the chances of the shares in a big gold company like Barrick, Newmont or Agnico Eagle being cut in half within six months are reasonably low, this could happen, and has, if you pick the wrong junior. Always do your due diligence and only invest an amount that you can afford to lose.
5. Gold futures. Gold futures are contracts in which you agree to buy a set amount of gold at a price and time in the future. Futures are traded in contracts, not shares, and represent a predetermined amount of gold. They typically require a minimum purchase of 100 ounces, limiting their appeal to retail investors. People often use futures because the commissions are low, and the margin requirements are lower than with regular stocks. Some contracts settle in dollars, while others settle in gold.
Another possibility to consider is options on gold futures or options on a gold ETF. These contracts represent the right to buy or sell gold at a set price for a given amount of time. Options may be a good vehicle for trading gold if you think the price is going up or down. The risk is limited to the premium the investor pays to enter the contract. In the United States, put and call options on gold futures can be bought and sold through a futures broker, on the Chicago Mercantile Exchange.
Richard (Rick) Mills
aheadoftheherd.com
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