Investing in Gold as an Individual Investor

Gold is the most famous metal and is used as a store of value/investment/hedge, component in jewelry, industrial metal (teeth filings, health care) and as a central bank instrument to back up monetary reserves.

Individual investors can invest in gold either directly or indirectly in various ways, including:

Physical Bullion

This is the purchase of physical gold. The price that an investor purchases for may be well below spot prices due to the lack of buying power of an individual. For this to be profitable, there is a higher price that needs to be surpassed.

Gold Exchange Traded Funds (ETFs)

Major exchange traded funds such as NYSE:GLD are backed up by an underlying gold reserve. This offers an investor the most liquidity and the lowest unit cost of carry.

Gold Futures

Gold is a liquid future traded on various exchanges.

Gold Miners and Explorers (Stocks)

These are leveraged bets on gold but can be augmented or held back by idiosyncratic (firm-specific) risk, financial leverage and operating leverage. A bad gold company can go to zero even if gold skyrockets. A reasonable company can translate into a leveraged bet on gold. The more junior the gold company, the more torque it has moving either way in the same direction as gold. Gold companies include explorers, developers, producers, and streaming companies.

Gold miners have operating and financial leverage. The company is theoretically the present value of its reserves to be sold. If the gold price makes reserves uneconomical to extract, the company simply becomes real option value.

The more senior a gold company, the more it becomes priced as an operator instead of a call on gold. An investment in a major gold miner such as Goldcorp or Barrick becomes a bet on management and other corporate specific factors that may cause the stock to be influenced by more than just the gold price.

Gold’s Performance as an Asset Class and Portfolio Strategy

Gold is an asset that has over extended time horizons consistently underperformed returns on stocks and bonds. Accordingly, given the popularity of gold, an investor must ask “Is gold an appropriate investment for a personal portfolio?”

The answer is possibly. There are three reasons to invest in gold:

Using Gold to Hedge

If looked at as a hedge against market volatility held in the portfolio similarly to cash, there is merit behind holding gold. Most academic texts look at 3-5% of a well-diversified portfolio being allocated to gold. Historically, gold has done well during times of market turmoil.

Using Gold to Speculate or Bet

This is a bet on timing and correctly guessing macroeconomic variables and how the market reacts in terms of the price of gold.

Using Gold as an Investment

This is the long-term holding of gold for price appreciation. As alluded to above, gold has consistently underperformed stocks and bonds in this regard.

It is important to remember that gold by itself is not an operating asset or a stake in an operating asset. It does not generate cash flow like a business, collect rent like real estate, pay a dividend like a stock or yield interest like a bond. It is simply a claim on a metal where price may deviate from the intrinsic value of industrial use.

In fact, holding gold directly or indirectly actually comes with carrying costs to pay for physical storage. If gold is purchased by an individual investor, the gold must be held somewhere and possibly insured. If gold is purchased indirectly through an ETF, these costs are passed on via fees, explicit or implicit, to the investor.

Notable investor Warren Buffett and other value investors have famously renounced gold as an investment:

“You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what it’s worth at current gold prices, you could buy — not some — all of the farmland in the United States. Plus, you could buy 10 ExxonMobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”

Recent Gold Price History

Gold is an interesting asset class that has historically been a safe haven and a risk-off asset (an asset that investors pour money into when markets are volatile and there is uncertainty).

Gold is a much less relevant commodity than oil in terms of daily trading volumes and importance to the world economy, however the metal had a substantial run up following the financial crisis as Central Banks adopted accommodative/expansionary monetary policy (quantitative easing) to stimulate the economies and boost inflation.

Gold rose precipitously as a result of the jump in the money supply. This trend was jumped on by traders and gold’s historical relationship as a risk-off asset decoupled. The economy was recovering and gold continued to rise before crashing and remaining range bound as Central Banks begin to unwind their monetary stimulus.

Gold now follows its historical pattern more closely as a risk-off asset while Bitcoin has become the new asset bubble.

Related Reading for Investing

Investment Asset Classes

Fixed Income – An introduction to bonds and other fixed income instruments
Index ETFs – An introduction to index ETFs and why they make sense versus most mutual funds
Avoiding Exchange Rate Fees at Banks for Investing and Travel
Gold
Real Estate
Taxes – All investors have to deal with taxes but it is important to know how to minimize tax drag on your investments through understanding TFSAs and RRSPs

Commentary on Investing

Investing

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