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The macroeconomic policies adopted by the United States Federal Reserve — also known as the Fed — and other central banks across the world as a result of the COVID-19 pandemic have increased the risk of inflation rates going up in the near future.
Statistics from the Fed show that almost 24% of all US dollars in circulation were printed in 2020 as the central bank had to ramp up its asset purchase program to prevent a financial cataclysm as a result of the pandemic-induced market crash of February-March of that year.
Economists seem to agree that excess liquidity could result in higher inflationary pressures once the economy recovers, while historically low interest rates can end up producing a multiplier effect as money will start to flow at a faster rate once the economy gets back to normal.
In this particular environment, gold emerges as an appealing hedge against the erosion that higher inflation rates can cause in your US dollar savings and investments.
Therefore, if you believe that the US — and the world for that matter — is heading to a period of higher inflation, the following article will show you how you can invest in gold to protect your assets from losing their purchasing power.
How to Invest in Gold
There are multiple financial vehicles through which investors can get exposure to the yellow metal including gold futures, bullion, gold exchange-traded funds, and even gold mining companies.
Gold ETFs & Mutual Funds
Exchange-traded funds and mutual funds are perhaps the most popular vehicles through which investors can hold gold nowadays without facing the disadvantages associated with storing and protecting the precious metal if they decide to buy it directly in the form of jewelry or bullion.
These funds mimic the performance of spot gold prices by either buying and holding bullion or using derivatives such as futures and options to track the price of the yellow metal.
When it comes to ETFs, there are hundreds of funds managed by various financial services firms from different corners of the world. However, these are the two largest ETFs currently offering exposure to gold:
- SPDR Gold Trust (GLD)
- AUM: $57.47 billion
- Managed by: State Street
- iShares Gold Trust (IAU)
- AUM: $28.04 billion
- Managed by: BlackRock
Meanwhile, you can also invest in dozens of different mutual funds that offer exposure to the yellow metal as well.
However, keep in mind that mutual funds tend to be more expensive as an investment vehicle compared to ETFs and there could also be liquidity considerations to take into account when picking mutual funds over ETFs to invest in gold.
These are three of the largest mutual funds offering exposure to gold:
- First Eagle Gold Fund (SGGDX)
- AUM: $2.28 billion
- Managed by: First Eagle Investment Management
- Fidelity® Select Gold Portfolio (FGDAX)
- AUM: $1.72 billion
- Managed by: Fidelity
- Sprott Gold Equity Fund (SGDLX)
- AUM: $1.10 billion
- Managed by: Sprott
As you can see, ETFs tend to attract more capital than mutual funds due to their higher liquidity and lower holdings costs. Gold ETFs can be bought and sold on major online brokers like E*TRADE, Firstrade, and TradeStation.
An exchange-traded note (ETN) is a debt instrument that can be bought through a traditional exchange although it works differently than an ETF.
An ETN acts as a bond but its price moves in line with that of gold instead of supply and demand. This means that the value of the ETN is pegged to the value of an index that tracks the price of gold.
Once the ETN reaches its maturity date, the issuer will liquidate the position by transferring the final value of the ETN to the holder of the note.
Different from ETFs, ETNs don’t hold gold or any derivatives. Instead, these notes are backed by the issuer’s balance sheet and, therefore, they are considered riskier due to the inherent credit risk.
The upside of ETNs is that holding costs are commonly lower than investing in gold through an ETF. However, liquidation risks are one particular downside of this instrument since the contract could mature at a point where gold prices are temporarily lower, causing a loss to the holder as the investor will be unable to extend the holding period and wait for the price to bounce back.
ETNs are not typically recommended for beginner investors. Instead, they are much more suitable for sophisticated traders who might be seeking to profit from short-term upticks in the price of the yellow metal. Gold ETNs can be bought and sold through online brokers like Public.
✎ Editor’s Note
ETNs are more complex than your regular gold ETFs since they don’t physically hold the asset in trust. The price of an ETN tracks a commodity index.
Gold Futures & Options
Gold futures are an instrument that entitles the holder of the contract to receive the physical delivery of a certain quantity of the precious metal if the agreement is not sold before it matures.
Futures contracts expire within 30 days and can be purchased through an online securities broker. The price of gold’s front-month futures contract — which is the contract that is next in line to expire – is commonly similar to that of the spot market.
On the other hand, contracts that expire on future dates often have a different price depending on the market’s expectations of where gold prices might be a month or a year from now.
Gold futures offered by the CME Group, for example, entitle the holder to receive 100 troy ounces of the precious metal — which is around 6.85 pounds.
The upside of using gold futures to get exposure to gold is that you can exercise your contract once the expiration date is reached and you will receive physical gold in exchange.
On the other hand, there are two risks associated with investing in gold futures. The first is rollover risk. Since futures contracts expire every month, if you are looking to hold gold for longer than that you will face rollover risks, which means that you might incur a loss when you are forced to liquidate the front-month contract to purchase next month’s contract.
Moreover, assignment risks should also be taken into account. This means that failing to roll over your contract before it expires could result in the assignment of the corresponding 100 troy ounces you are entitled to, meaning that you’ll have to take delivery and manage the storage and protection costs associated with holding bullion.
Gold Mining Stocks
Gold mining stocks are another way to get indirect exposure to gold. Here, investors buy shares of companies that mine the precious metal and sell it on the open market for profit.
On the other hand, you could buy an exchange-traded fund (ETF) that invests in gold mining stocks such as the VanEck Vectors Gold Miners ETF (GDX) — the largest ETF covering this industry — or the iShares MSCI Global Gold Miners ETF (RING).
Historically, the correlation between the performance of the GDX and the spot price of gold has been above 0.70 most of the time except during periods of significant turmoil in the financial markets.
Therefore, even though investing in gold miners does not offer the same returns as buying bullion or investing in an ETF tracking gold, the performance is similar and you could receive dividends for your investment in case the company or the ETF offers quarterly or annual distributions. Check out our best online brokers’ guide to trade stocks.
A gold bullion — also known as a gold bar — is a big piece of physical gold that weighs 400 troy ounces or around 27.43 pounds. These gold bars are 99.5% gold and they are produced by mints, including the Royal Canadian Mint, the Perth Mint, and Valcambi.
Bullion can be bought from multiple sources yet the process involves more than just going to the shop and purchasing a gold bar. Given the value of each bar — currently sitting at around $712,000 each — there are multiple risks associated with holding bullion.
First, unless you are buying directly from the mint or a regulated dealer, you should verify that the gold bar is made of pure gold based on industry standards. Moreover, there are storage costs that can add up to your expenses and possibly eat up a portion of your gains if the price of gold goes up.
Additionally, there are safety risks including the possibility that your gold bar can be stolen unless you store it in a safe place — which generates an additional expense.
For example, according to BullionVault, the cost of buying 1oz of gold and storing it for a month is around $21.76 including around $18 in brokerage fees and $4 in storage fees.
If you plan to hold gold for longer than that, let’s say 12 months, storage costs go up to $48 per year. Therefore, the total cost of buying 1oz of gold would go from $1,776 to $1,842 which results in a 3.7% holding cost that could easily eat up your annual gains.
✎ Editor’s Note
If you plan on buying physical gold, make sure you buy it from a reputable dealer and you’re able to verify the bars’ purity, form, size, and weight before purchasing it.
Gold Coins & Jewelry
Gold coins and jewelry are an alternative to buying bullion if you don’t plan to invest hundreds of thousands of dollars in buying a gold bar or if you prefer to store your gold at a personal safe.
Coins and jewelry come in different shapes and it would depend on the buyer’s preference what kind of coin or piece of jewelry he or she would like to buy to invest in gold.
The US mint sells a wide variety of gold coins that you can buy safely to invest in the precious metal. For example, the mint is currently offering a limited American Liberty One-tenth ounce gold coin valued at $290 that is 99.9% pure gold.
Most mints will extend you a certificate of authenticity for your coins and you will probably find it easier to sell them or exchange them for other goods with a third party based on the spot price of gold at the time of the transaction.
Additionally, you can buy rare gold coins that could also hold value as a collectible aside from the value of the material itself.
As for jewelry, a well-reputed local store can sell you pieces made entirely of gold and you can either store them at a place you deem convenient or you can rent a safety deposit box at a local bank. The same applies to gold coins.
Benefits of Investing in Gold
- Historically, gold has performed well during times of economic hardship.
- Gold is considered a store of value, which means that it tends to preserve its purchasing power during cycles in which fiat currencies are losing theirs.
- There are multiple alternatives to invest in gold nowadays that minimize storing costs and security risks.
- Gold is accepted around the world as a means of payment and it can be easily exchanged for fiat currency.
- There are multiple sources of demand for gold, which guarantees high liquidity and relative stability in price.
- Gold and other precious metals can be treated as a separate asset class and, therefore, investors can use it for portfolio diversification.
Downsides of Investing in Gold
- Gold holdings don’t generate any kind of recurring income.
- For large quantities, storing costs can be quite high.
- Gold can be stolen and melted, which makes it impossible to establish prior ownership.
FAQ About How to Invest in Gold
We’ve found some of the most frequently asked questions with regards to investing in gold. Here are our answers.
Why Should I Invest in Gold?
A survey conducted in 2020 found that almost 11% of Americans owned gold in some of the forms outlined above.
Gold’s popularity results from being perceived as a good store of value and hedging instrument during times of higher inflation.
Additionally, gold can serve as a good instrument to diversify your portfolio during times in which equity valuations are unjustifiably high.
Is Investing in Gold a Good Way to Hedge Against Inflation?
A study conducted by Oxford Economics in 2008 indicated that “gold may perform especially strongly in more extreme economic scenarios featuring high inflation, a weak dollar and elevated levels of financial stress”.
The study analyzed gold’s historical performance against multiple other variables and financial instruments, including the US gross domestic product, the dollar, and real interest rates to make this assessment.
Their findings indicate that gold can be a suitable hedge if one expects a future spike in inflation rates.
Is Gold Investing Good During a Recession?
In a recessionary cycle, the Oxford study finds that gold would become more appealing to investors as riskier assets will suffer due to the poor shape of the economic environment while accommodative monetary policies will likely result in fiat currency debasement and a corresponding lost faith in the strength of its purchasing power.
What Percentage of My Portfolio Should be in Gold?
Based on the Oxford study, the optimal allocation for different types of investment portfolios ranges between 4% and 9% depending on the investor’s risk appetite and whether other assets that serve as a hedge as well have also been incorporated into the portfolio.
How Well Does Gold Hold Its Value?
The Oxford report indicated that, historically, the performance of gold had little to no correlation with the performance of other asset classes including cash, equities, and property.
The uncorrelated nature of gold means that its price is not dependent on the overall state of the financial markets as, instead, the price of gold behaves uniquely.
What Determines the Price of Gold?
The price of gold, like any other financial asset traded in public markets, is determined by supply and demand dynamics.
Meanwhile, multiple factors can influence any of these two forces including the following:
- Gold mining output
- Investors’ appetite for gold
- Demand from the jewelry industry
- Demand for industrial uses
- Demand from central banks and other financial institutions
- Political environment and perceived geopolitical risks
- Interest rates
For centuries, gold has been a symbol of stability and wealth. Most studies of the performance of the precious metal during lengthy periods have found that it is one of the best vehicles for hedging against inflationary pressures and performs quite well during recessionary cycles as well.
Therefore, given gold’s strong appeal as both a store of value and hedge, investing a portion of your portfolio in it seems like a wise decision in a time when central banks have rushed to print trillions of dollars to contain the economic and financial fallout caused by the pandemic.
You now know how to invest in gold by using any of the vehicles outlined above but you’ll have to be the judge as to when and how much you will be putting into this fascinating financial asset.
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Alejandro is a financial writer with 7 years of experience in financial management and financial analysis. He writes technical content about economics, finance, investments, and real estate and has also assisted financial businesses in building their digital marketing strategy. His favorite topics are value investing and financial analysis.