🏆 Your Guide To Investing In Gold
Gold is arguably one of the first precious metals known to humanity. It’s unclear exactly when humans first began to use gold, but the first use of gold as a concept of money was in 700 B.C. and has been a symbol of wealth ever since. Even early paper currencies were linked to the value of gold, up until the 20th century. Nowadays, gold still has a role in the global economy, whether as a store of wealth, or its applications in industry and technology.
What Can It Do For You
🛡️ Protection. Gold is often viewed by investors as a safe haven asset, a way of preserving wealth in times of instability, inflation and market volatility. It generally performs well when currencies lose their purchasing power. Since gold tends to move in the opposite direction as stocks and bonds, it can help diversify your portfolio, lowering its volatility and reducing risk.
What Affects Gold Prices
There are several key factors that are involved in moving the price of gold:
- 🏗 Gold Production — Supply. As a commodity, gold prices are dictated by supply and demand. When gold production levels fall, prices tend to go up, and vice versa. Though gold mining operations exist on every continent except Antarctica, new gold deposit discoveries are becoming increasingly rare. Gold mining production currently satisfies about ~75% of global demand each year, with recycled gold (from jewellery and gold extracted from technology) making up the rest.
- 🏦 Central Bank Policies & Reserves. Monetary policies set by central banks, such as setting interest rates and deciding whether or not to print more money, can affect gold prices. It’s widely believed that if interest rates are high, it makes gold less attractive as other investments, like fixed-income investments, can provide higher returns due to the higher rates. In addition, printing more money could lead to inflation, which drives demand for gold.
- 💵 The Value of the US Dollar. Because the US dollar is used as a benchmark for the pricing of gold globally, they usually share an inverse relationship. Since gold has inherent value, whenever the US dollar loses its value, it usually increases the price of gold, and vice versa.
- 🌋 Geopolitical (Un) Certainty. Gold prices tend to perform well during moments of turmoil, conflicts and crises, as we see now with the current pandemic. This is because uncertainty creates volatility in the markets, and can negatively impact stocks and bonds, so investors tend to flock to gold to preserve their wealth.
- 🌍 Globally Diverse Market Demand. Demand for gold is global and is driven by a range of factors, including investors, both individual and investment funds, to a wide range of sectors, industries and technologies.
Where Is Demand Coming From?
There are four main areas that drive demand:
- 💎 Jewellery. Gold is arguably the most popular precious metal in the jewellery industry. Asian demand (particularly China and India) fuels much of this industry’s growth due to the metal’s cultural importance as well as the evolving middle-class.
- 🏭 Industry & Technology. Gold’s unique properties (conductive, catalytic, malleable, biocompatible, etc.) means it’s used in many tech and manufacturing industries, such as healthcare, consumer electronics, aerospace, renewable energy, and many more. Gold will also play a role in the development of new technologies in the future.
- 💸 Private Investments. These include physical gold bullion bars, coins, and ETFs, funds and other similar products that invest in gold. Investors, both individuals and funds, see gold as a way to preserve wealth and minimise losses during market volatility. According to the World Gold Council, the amount that investors have bought per year has increased by at least 235% over the last three decades.
- 🏦 Central Banks & Other Institutions. Central bank reserves in many countries hold a significant amount of gold. The US leads the pack, holding approximately 8,133.46 tonnes. These institutions buy gold to protect the strength of their respective currencies in the event of inflation.
A recent quarterly report from the World Gold Council showed the impact of coronavirus on demand: a massive increase in gold ETFs and related products and slower consumer jewellery demand. Central banks and other institutions have continued to buy, though at a relatively lower amount than the previous quarter.
The Case Against Gold
Warren Buffett famously (or rather, infamously) said this about gold: “[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.” Mr. Buffett’s disdain for gold isn’t simply because it’s a precious metal, as between 1997 to 2006, his investment fund Berkshire Hathaway hoarded a staggering 130 million ounces of silver. As an investment, gold is unproductive and does not generate dividend payments and pays no interest, unlike stocks and bonds. When it comes down to it, it’s worth what people are willing to pay for it.
The Case For Gold
Although gold doesn’t provide dividends, gold serves well as protection against uncertainty, volatility, and inflation. In this current climate, where central banks are holding low interest rates to stimulate the COVID-battered economy and avoid a recession, where geopolitical unrest is occurring worldwide, where there is political turmoil in the US, hedge fund manager Ray Dalio said, “I believe it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.”
Popular Ways To Invest In Gold — Pros/Cons of Each
There are many ways in which you can buy/invest in gold. Here are some of the more popular methods:
- Physical Gold (Bullion Bars & Coins). You can buy and directly hold physical gold bullion bars and/or coins. There’s no doubt to the ownership of these assets, and is reliable. However, you may want to consider storing it securely, like a safety deposit box, rather than at home. Further, you may be faced with several fees — the cost to convert raw gold into finished bars and coins tends to be passed on to you, as well as commission fees for the broker acting as the middleman. Selling it may also prove to be an issue as the broker may buy it back at below market prices. Alternatively, there are government-owned mints (if not possible, reputable online gold brokers) where you can physically and/or digitally buy physical gold, with the option to store at their vaults for a fee.
- Gold ETFs. Gold-backed Exchange-Traded Funds are very popular for many since you don’t have to bother dealing with physical gold, and yet, still have exposure to real gold market prices. These are traded on the stock exchange, which means you’ll be able to buy and sell these assets very easily. However, there are no assurances that you actually own the physical gold. You also won’t be able to take delivery of your gold. Depending on which broker you go with, you may be charged with trading commissions. ETFs also charge an expense ratio, or management fee (about ~0.40%, depending which ETF you choose), that gets taken out of their total holdings and is then reflected on your account.
- Gold Stocks. These are shares of gold mining companies. Like ETFs, they can be bought and sold easily. There are no fees, apart from trading commissions depending on your broker. They don’t necessarily follow the price of gold since company profits and stock market movements need to be taken into account. Additionally, many mining companies produce and mine a range of other metals, which may be an added bonus. However, you’re exposed to a greater number of risks involving company profitability, exposure to price movements of other metals, etc. Because of all these extra factors, you may not get much exposure to market prices of gold. You may want to consider looking at the company’s annual reports, portfolio of what mines they have, and potential expansion plans.
- Gold Futures Contracts. A binding agreement between two parties where they agree to buy/sell gold at a specified time in the future with an agreed-upon price. These are traded on futures exchanges, so they are relatively easy to buy/sell. If gold prices increases above the agreed upon price, you profit. If not, then the seller profits. The main problem with futures contracts is that they are highly leveraged. This means that you are borrowing money so you only have to pay for a fraction of the total amount. Because you are using a significant amount of borrowed money, even small price changes in gold can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, exchange/clearing fees, and more.
TL;DR — Is It The Right Investment For You?
Gold can be effective as a way to protect your wealth against inflation and reduces overall portfolio risk since gold tends to move in the opposite direction to stocks and bonds, which means your investments won’t solely be subject to stock market fluctuations. That being said, gold can also be volatile due to the price drivers mentioned above. There’s no one right way to own gold as everyone will have different expectations, goals, risk positions and strategies. However, as a rule of thumb, several studies (Bruno & Chincarini (2010), Sherman (1982), etc.) suggest that you should limit gold to roughly 5–10% of your portfolio.
If you are considering adding gold to your portfolio, it may be best to buy small amounts over time. Not only can this minimize your risk in losses if gold prices were to drop, you could also profit when prices are low. This is referred to as dollar-cost averaging. It also means you can slowly build your gold position up to gain the benefit of diversifying your portfolio in the long term. However, if you are unsure, as always, check in with a professional financial advisor before making any moves.
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