Gold 2011

The Many Ways to Invest in Gold

How can an investor get into gold? Let's start with the obvious.

Gold bars and coins.

Gold coins and bar
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Gold bars can be bought and sold fairly easily. While the most well-known of all gold bars is the London Good Delivery Bar, which weighs approximately 400 ounces (nearly $700,000 at current prices), many companies produce smaller bars that can also be bought and sold.

Gold coins can be minted as legal tender in the country in which they are minted — that is, they have a face value independent of the amount of gold in them — or the market value can be determined solely by the value of the gold (minus any dealer markup).

The South African Krugerrand, first minted in 1967, is far and away the most widely minted gold coin. It contains one ounce of pure gold, though it's actual weight is slightly greater — 1.09 ounces, the balance being copper. There have also been half-ounce, quarter-ounce, and one-tenth ounce denominations.

Several other countries have issued gold coins, including the Canadian Gold Maple Leaf (produced by the Royal Canadian Mint in 24-carat, pure, gold), the Australian Nugget (minted by the Perth Mint, also 24 carat), the British Britannia (22 carat gold, the remainder being silver, but still containing an ounce of pure gold), and the American Gold Eagle (22 carats, the remainder a mixture of copper and silver, but also containing an ounce of pure gold).

The World Gold Council maintains a list of U.S.-based dealers in gold bars and coins , and one of the widest sources of information on physical ownership of gold bars and coins is .

What about storing it?

You can keep your gold bars and coins in your house, or in a safe deposit box. An alternative is to create an account with a gold-bullion bank and let them store the gold for you.

For most investors, gold accounts are not a practical form of investment, since most bullion banks required large minimum amounts of gold to be held on deposit, and typically only provide vaulting services for large customers that also hold other assets with the bank.

Gold is held by bullion banks in two different types of accounts — allocated and unallocated accounts.

In an allocated account, specific gold bars or coins are identified and assigned to your account. You have full ownership of the gold, but you also pay storage and insurance charges.

In an unallocated account, you do not have specific ownership of gold bars, you only have a claim on the gold stock held by the dealer.

Clients are technically unsecured creditors. Bullion banks will typically lease gold in unallocated accounts. In both cases you can take physical ownership of the bars, usually within two working days.

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A number of private companies provide purchasing and gold vaulting facilities. They include BullionVault and Gold Bullion International .

Buying a bit at a time

Some banks and brokerage firms have established gold accumulation plans that allow investors to buy small amounts of gold every month. These are typically in pooled accounts. The World Gold Council also recently announced a similar gold accumulation plan in China.

Futures, Options, and ETFs

Futures and options

Many countries support trading in gold futures. These are binding commitments to make or take delivery of gold on a specified date at an agreed price. The advantage: leverage. Trading on margin (a cash deposit paid to your broker) is less expensive than the price of the contract. ?

In New York, the New York Mercantile Exchange Comex Division (recently rebounded CME Globex, and now a unit of the CME Group ), is the principle venue for trading gold future contracts in the U.S.

But the U.S. isn't the only place gold futures are traded. The Dubai Gold & Commodity Exchange, DGCX), the Multi Commodity Exchange, MCX, in Mumbai, the Tokyo Commodity Exchange, TOCOM, and the National Commodity Exchange Limited in Karachi all support trading in gold futures.

To directly trade gold futures you need a futures trading account.

Gold options give the holder the right, but not the obligation, to buy or sell a specified quantity of gold, at a predetermined price, by an agreed date.

Exchange traded products

There are now many ways to invest in gold without the need to take physical possession.

Exchange Traded Funds, ETFs, are designed to track the spot price of gold and are backed by bullion held in vaults. They include:

SPDR Gold Shares, far and away the largest, sponsored by World Gold Trust Services (wholly owned by the World Gold Council), a trust backed by gold held in a vault in London (see the section on "Answering questions on gold ETFs" below).

  • iShares Gold Trust, also a trust backed by gold bullion.
  • ETFS Physical Swiss Gold, which is backed by gold bullion held in Switzerland.
  • ETFS Asian Gold, which is backed by gold held in Singapore.
  • PowerShares DB Gold, which is composed of futures contracts on gold.

The Central Fund of Canada and the Central Gold Trust are Canadian closed-end funds. The CEF holds a mix of gold and silver in about equal amounts; the GTU holds primarily gold.

The Sprott Physical Gold Trust, while legally a trust, trades as a closed-end fund. It holds physical gold stored at the Royal Canadian Mint. This fund, unlike the others, allows shares to be redeemed for whole gold bars, but only whole bars.

Mining companies.

This seems fairly simple, since if the price of gold rises, and a mining company can produce gold at a relatively fixed price, its profits should rise.

In theory, gold mining companies can produce "alpha" — returns in excess of the price of gold simply rising. They can do this by purchasing and selling other gold companies and mines and by reducing costs, for example.

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Unfortunately, it's not nearly that simple. Mining companies have their own forms of risk:

Corporate risk. They are subject to the usual corporate risk of mismanagement and miscalculation.

Commercial risk. Mining is inherently dangerous and subject to flooding, cave-ins, and explosions; mining companies can and have been sued many times for dangerous working conditions.

Political risk. As with oil, the more profit that is made from gold, the more pressure there is to share those profits. Many countries are putting more pressure on mining companies to increase the amount paid to them.

Production risk. Different mines produce gold at greatly different costs, depending upon what country they are in, depth of the mine, difficulty of getting at the gold, taxation, etc. For example, according to the GFMS Gold Survey 2011, most Latin American mines can produce an ounce of gold at a cost of about $400 an ounce. South Africa, by comparison, produced gold at close to $800 an ounce. Infrastructure challenges and electricity problems can cramp production as well.

Hedging risk. Unhedged mining companies leave themselves open to fluctuations in the price of gold, which means their profits can swing wildly from year to year. Many mining companies adopted aggressive hedging strategies to smooth out their earnings. However, when the price of gold began skyrocketing several years ago, many gold companies began taking off their hedges. Gold miners have generally benefited from removing hedges, but the cost of doing so has been enormous.