So, Do You Want to Be a Goldbug? Ways of Investing in Gold

Feb 22, 2021 06:44 PM ET
So, Do You Want to Be a Goldbug? Ways of Investing in Gold

How many ways can one invest in gold? The main options of investing in this precious metal are derivatives, stocks and ETFs, certificates, and ownership of bars and coins. Each of these presents its own pros and cons, affecting everyone differently depending on their intention, affordability, and expertise.

Many figures – both past and present – have uttered powerful quotes about gold. One such expression, by Hans Sennholz, is, “No other commodity enjoys as much universal acceptability and marketability as gold.” 

Gold, out of all precious metals, is the most attractive option, though not without its fair share of divided camps who either lobby for its unmatched value or believe it’s worthless. Nonetheless, gold has always been a fascinating financial instrument. 

This article covers just four of the popular methods one can use to invest in gold.

Derivatives

A derivative is a non-physical tradeable financial instrument deriving its value from an underlying asset. In the case of gold, one of its derivatives would be based according to the price per-ounce against another financial market, most popularly the US dollar (known by the ticker symbol XAU/USD). 

We can find gold derivatives in many securities such as forex (decentralized market), futures, options (centralized markets), etc. The main purpose for this type of financial security is for speculation because of the trading flexibility afforded to participants through leverage and the astronomical liquidity provided by market makers.

Derivatives also apply for those looking to hedge their positions or investments or those looking for less commonly traded markets.

Stocks and ETFs

Stocks or shares are another financial instrument involving gold and are different from derivatives in that they provide some form of equity. The primary way of gold stock investing is through mining companies listed on several exchanges.

Proponents behind investing in a mining company believe that when gold prices increase, this should consequently increase the value of their stock. However, this correlation is a generalization, though it is still a better option for those not interested in bearing the cost of buying gold outright. 

Some of the largest gold mining companies are Barrick Gold, Newmont Goldcorp, Kinross Gold, to name a few. As a subset of the gold stock investing, an ETF (exchange-traded fund) seeks to act as a collection of several gold-related markets, most commonly stocks (but it can also be commodities, bonds, etc.). 

Private financial companies are responsible for the managing of ETFs, and they attract investors to invest in them in the hope of profiting at a later stage. The SPDR Gold Trust, iShares Gold Trust ETF, and Invesco DB Gold ETF are some of the many gold ETFs available on the market.

Certificates

A gold certificate is a document typically issued by a bank, investment company, or gold maker denoting ownership of a specific quantity of gold instead of owning the solid asset itself. We can trace the gold certificates tradition back to the 17th century where people kept their gold with goldsmiths, who then issued these documents as proof of ownership.

Eventually, the certificates acted as a medium of exchange like cash, with many in several countries like America, England, and the Netherlands resembling the size of banknotes. Governments eventually prohibited the use of certificates in the 1930s. 

Thus, any certificates that have survived since then are now highly valuable due to their scarcity.

The purpose of this certificate in the old days remains the same today in that it proved possession of the gold without having visual proof.

Gold certificates are not a common investment approach, making them riskier as if the issuing body goes under, the document becomes worthless. Furthermore, very few prominent nations still issue new gold certificates, namely banks and mints or manufacturers in predominantly gold-producing nations like Australia, America, Canada, etc.

Physical gold

Saving the best for last, we have physical gold, specifically coins and bars. Gold enthusiasts consider this method the only true way of physically owning the precious metal because of its disassociation with the financial system or any native currency. 

Gold coins, which were previously used historically as legal tender, are now collectible items deriving a value based on their rarity and condition. Popular gold coins include the likes of South Africa’s Krugerrand, the American Gold Eagle, and the Australian Kangaroo, to name a few.

On the other hand, gold bars are good purely for preserving wealth over the long-term and can be designed according to a specified gold weight. Bars usually contain almost 100% pure gold and are more cost-effective than coins. There are several manufacturers investors can approach to make these bars, though not every country may have these physically in their territory.

Which methods are the riskiest?

As with any financial instrument, gold bears some risk despite the allure and respect it has garnered for centuries. Several factors affect which avenue investors take when investing in gold, like their intention, affordability, knowledge, and so on. 

The risks of physical gold

From a convenience perspective, physical gold is probably the riskier choice for several reasons. For one, the barrier to entry is higher as just one troy ounce costs $1,771 (at the time of writing).

Secondly, because of the value, hoarders have to consider additional storage and insurance costs. Furthermore, solid gold is a lot harder to sell in a hurry, though its actual purpose was never for ‘quick trading’ like derivatives. 

Many people owning real gold do so for the legacy aspect of wealth preservation. The other advantage of physical ownership over the other avenues is there is no counter-party risk, and the gold has no ties with any financial system.

The risks of derivatives, stocks, and ETFs

Derivatives, stocks, and ETFs are far more convenient as they exist digitally. Where physical gold provides one with the tangibility of ownership, many analysts will argue that the digital means are merely replications and hold no intrinsic representation of investing in the physical metal.

They cite reasons centering around the premise that many of these forms have links to the performance of fiat currencies, which themselves are inflationary and lose value. Goldbugs who advocate for physical retention have little faith in the legal tender we use in this world. 

This challenge presents a counter-party risk not found in hoarding the real gold. Drawbacks aside, the digital avenues are still more accessible and have a much lower entry barrier cost-wise.

Perhaps the most significant benefit is the liquidity as there are million-dollar liquidity providers who make buying and selling lightning-quick with little waiting. Hence, instruments like derivatives are best for trading, while stocks and ETFs are better for investment purposes with the same advantage of enormous liquidity.

Conclusion

Civilization has advanced in leaps and bounds in offering numerous ways of investing in the most precious metal known to humanity. It has continued to maintain its status as a rare commodity, even with many other investments looking to replicate what it stands for.


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