Investors always try to diversify their investments and lower their risk. They especially look for so-called safe haven investments that perform better when the rest of the market down.
Of these safe-haven investments – treasury bills, francs, and others, investors consider gold to be the best. That’s why you’ll find that investors often include some gold in their portfolios.
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Gold as a Commodity
Like any other commodity, the price of gold is determined by supply and demand. The most of the world’s gold comes from the hard rock mining, but it can also be produced using placer mining methods or as a by-product from copper mining. China, Australia, and Russia are the largest producers of gold in the world. When it comes to demand, gold’s main use is for jewelry production. But, it’s also used in the aerospace industry, medicine, dentistry, and electronics. Governments and central banks are buyers of gold.
Currently, the U.S. is the largest gold holder, while Germany comes second and the International Monetary Fund is in the third place. Private investors are also interested in buying gold and they treat the purchase of gold as an investment.
Why are Private Investors Investing in Gold?
Instead of holding a cash position, investors may buy gold when they expect a recession, geopolitical uncertainty, inflation or a depreciation of a currency. Sometimes they hold it as an insurance from the market decline. You can’t always forecast unwanted events, so it makes sense to hold assets that do well as protection from a market decline. In the last 40 years, gold recorded significant gains from 1978 to 1980 and from 1999 to 2011. It struggled during the 90s and after 2011. Fears of inflation and recession led gold to its 1980 highs, while several events caused gold to trade higher after 1999. The September 11 attacks and the war in Iraq held the price higher until 2003.
Insurance buying was behind gold’s move higher going into the 2007 recession. It continued its uptrend as the market traded lower, with economic uncertainty as its main theme. Problems in Europe, weaker U.S. dollar, concerns over economic recovery kept the gold price high until 2011. Gold is not always performing well. It has struggled during the 90s due to growing U.S. GDP, interest rate hikes in 1995, and a tight fiscal policy. After 2011, the strength of the US dollar and the US economy hurt gold. The stock market broke out of a downtrend and turned in the uptrend and investors were not as interested in owning gold as an insurance.
Now you know a little more about gold and why people may invest in it. Here’s how you can start investing in gold.
1. Buy physical gold
If you want to get exposure to gold, one way to do it is by purchasing gold jewelry, coins or bullion. Gold bullion trades very close to the price of gold and it can refer to gold bullion bars or gold bullion coins.
Bullion doesn’t have any artistic value, which makes it different from jewelry or numismatic coins. To buy gold bullion you have to pay a premium over the gold price which can be in a range from 3 to 10 percent. You will also have to use a vault or a bank deposit box to store it. You can buy physical gold online, in a jewelry store, or another gold storefront.
Before you purchase, make sure the price is fair, the gold is real and tested, and that you aren’t paying a higher premium for collectors coins if you’re just looking for pure gold. Be prepared to walk away if these standards cannot be met, especially if an online store or storefront feels shady.
Once you buy gold, you have to store it properly. You could store it at home, but some security issues could arise from this approach. If you decide to purchase and keep it at home, make sure you have a proper safe and take the necessary measures to protect your assets.
2. Buy gold futures
Futures contracts are standardized contracts that trade on organized exchanges. They allow a holder to buy or sell an underlying at a specified time in future and at the price from the futures contract. First, you’ll need to open a brokerage account. Check out Benzinga’s Best Futures Brokers rankings to start trading. Here’s how it works.
Gold futures contract at Chicago Mercantile Exchange covers 100 troy ounces. To trade it, you need to deposit an initial margin, which is a minimal amount necessary to open a position. Every day your position is going to be marked-to-market. This means that if the price goes in your direction, you’ll make a profit, but if it goes against you, you’ll lose money.
If your account drops below maintenance margin, you will have to transfer money to your account to meet the amount of initial margin. Futures contracts are leveraged instruments. You need to only need your account balance to be equal to the initial margin, which is lower than the value of the whole contract. Most brokers do not have the delivery option, so the contract is settled in cash when it expires. The expiry is also standardized feature of the gold futures contract and investors can choose their time horizon while keeping standard expiration in mind. Later expiry contracts prices can be higher than the spot price and earlier expiry futures. When this is the case, we say that the market is in a contango.
On the other hand, when the spot price or the price of early expiring contracts are higher than the price of later expiring futures contracts, we are in a backwardation. If you are buying gold when the market is in a contango, you will also have to pay a premium for later expiry contracts.
3. Invest in gold ETFs
If you are not a fan of investing in gold futures, you can try gold ETFs. Instead of owning futures contract and paying attention to maintenance margin, you can buy shares of ETFs and get an exposure to gold.
If you’ve never invested in ETFs before and want to start, check out Benzinga’s Best Online Brokers for ETF Investing to get started. Once you pick a brokerage, you just have to open an account and pick your preferred gold ETF.
The most popular gold ETF is SPDR Gold Shares (NYSE: GLD) and it costs 0.40 percent annually to own it. The ETF follows gold bullion price.
4. Invest in gold mining companies
An investment in gold mining companies offers exposure to gold, but the exposure is sometimes limited. These companies carry operating risks, which can break a correlation to the gold price. Gold miners are at risk of a default and their shares can trade lower in case of an operating problem with the company regardless of the price of gold.
ETFs seem to be the best way to invest in gold. If you don’t like to own futures and monitor initial and maintenance margins, you can just buy shares of an ETF and follow the price of gold bullion. GLD is a liquid instrument and it doesn’t have high transaction costs. Futures are sometimes tough to handle, so ETFs may be the right move.
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