Gold investing has become very popular during the boom of the commodities markets. How to invest in commodities in the best way is a subject that should be continually reviewed, as different financial products appear all the time. As you will read below, the different routes into gold investing come with different types of risk, and no methods are risk free. The challenge is to choose the best method for holding gold that achieves your investment objectives without adding intolerable risk to your portfolio. If you can’t find the right balance, then gold holding might not be right for you!
How to we Define ‘Best’?
When we evaluate which is the best way to hold gold, we will consider the methods from 3 points of view:
Security: Which methods are the safest? Which method has the least non-gold price risk? These risks include insolvency and theft.
Liquidity: Which method allows you to invest and encash your gold holdings as quickly as possible with no penalty.
Efficiency: Which way to hold gold gets you the best price or incurs the least expenses.
The Alternative Ways to Hold Gold
Derivatives. These are futures contracts or swaps with a specific expiry date. If you don’t know how a futures contract works, let me help you – don’t consider them!
BullionVault.com. A unique service (hence why we use their brand name) which allows you to purchase and trade gold within BullionVault’s private, large, audited gold vault.
Private ownership. Gold bullion coins and bars can be purchases from dealers or a government mint which will allow you to take delivery of the yellow stuff itself.
e-Gold or Digital Gold. These are digitally issued currencies that are normally issued by private companies, which can be bought for dollars and exchanged back. e-Gold companies have a marred past, with several companies becoming insolvent and management being indicted by the Feds for money laundering and embezzlement.
Gold Certificates. These are typically issued by banks & other financial institutions, which declare your entitlement to units of their gold bullion reserves held on your behalf. These can be allocated or unallocated. Gold certificates are not widely available, however the Australian Mint still operates a certificate program for global investors, and Perth Mint Gold is a listed version, which entitles its holder to a specific quantity of fine gold.
Gold Exploration & Mining Equities. Exposure to changes in the spot price of gold can be gained through owning part of a gold miner or explorer. When gold prices rise, so do their shares. Examples of gold miners are Agnico-Eagle Mines (AEM) and Goldcorp (GG).
SpreadBetting & Contracts for Difference (CFDs). Placing short term ‘spread bets’ with many of UK providers will provide a leveraged exposure to the gold spot price.
Best Way to Hold Gold: Safety & Security
From a security perspective, this is how I rank the gold holding methods (Rank 1 being best). For some investors, security is the critical factor in deciding upon a gold holding method. Definitions of security may vary from person to person. For instance, gold that is stored in a secure bank vault is less likely to be stolen, however a citizen with a grim world view may only settle for personally holding the bar, in the belief that gold in a distant vault could be appropriated by government should the economy implode.
#1 Government-Backed Gold Certificates – Especially when issued by the Australian Government, gold certificates offer the safest method of gold holding. The authority that issues them is triple AAA rated, the physical gold is stored in a bank, you will be placed on a register, so destruction of the certificate itself would not render your claim worthless. In the unlikely event that underlying gold was stolen, your certificate should still represent a binding obligation to the institution. You gold is exposed to regulatory risk though, as the Austrailian Government could legally ‘confiscate’ the gold if it found itself in dire economic straits. Do check the T&Cs of any particular certificates, as policies may change over time and from institution to institution. This security only applies to certificates which are physically backed by gold, contrasting with ‘unallocated’ gold certificates which are less secure.
#2 Physical Gold Exchange Traded Funds – Exchange traded funds are the lesser of the remaining evils. ETFs that hold physical gold should surely be infallable right? Wrong. In an attempt to increase margins, many ETFs actually loan out their assets to outside groups (such as hedge funds) in order to earn extra interest on their assets. This leaves physical ETFs exposed to the same counterparty risks as their synthetic ETF cousins. If the hedge fund collapsed – the ETF would incur heavy losses on this activity.
~ #2 BullionVault. BullionVault gold is stored and insured within a similar facility to ETFs, meaning their security is also excellent.
#3 Private Ownership – Unless you happen to own a bank, private ownership can be a risky business. Many investors keep their gold in safety deposit boxes, but these offer little ‘real’ protection in the event of fire, theft or flood, which have all happened in the past. Banks do not keep a record of what is inside a security box, and will not reimburse customers for lost/stolen items etc, unless it was due to the negligence of the bank. All items in security boxes still need to be insured for the full value, (however keeping the item in a security box will keep the premiums low).
#4 Derivatives – Derivatives are exposed to a similar set of counterparty risks. Participants in the futures markets collateralise their positions (offer security to cover potential obligations) which reduces counterparty risk to an acceptable level, however it still remains present.
#5 Spreadbetting – Spreadbetting firms, like other bookmakers, are supposed to ‘balance their books’ in order to leave them with no naked position. In other words, spreadbetting firms should earn commissions regardless of which direction the market moves. The potential for bankruptcy is still present, and while the Financial Services Compensation Scheme (UK) should bail out investors, this will provide little comfort to larger investors with monies owed of over £85k.
#6 Mining Equities – Mining companines are historically volatile assets to hold, due to their exposure to commodity prices (which is what we want) and exposure to management, financing and othe risks (which are unnecessary). Therefore holding a mining company is not a pure play on the price of gold, but also on the strength of management, the skill of their exploration team and the future of the regulatory and political environments in which they operate.
#7 Digital Gold – Digital gold is a digital currency issued by a private institution, which is accepted by some retailers online. The merits of digital gold are that digital gold prices shouldn’t ‘inflate’ in the same way that Fiat currencies weaken as a result of central banks creating new money. Digital gold companies have a history of collapsing and embezzling funds. A quick history lesson from its wikipedia page is enough to put you off digital gold for life. Digital gold companies are neither reputable or popular, and the ‘exchange rates’ used to buy and sell digital gold could leave you short changed, as digital gold was not designed as a speculative platform.
Best Way to Hold Gold: Liquidity
#1 Tie – Physical Gold ETFs, Derivatives, Mining Equities, Spreadbetting, BullionVault – I’ve awarded all publicly traded instruments & BullionVault as number one, as these can be sold or closed in a couple of minutes via an online broker, and the funds will clear to your bank account after a couple of days. For an investment that represents a physical good, the liquidity is fantastic. Note: Smaller ETFs and mining companies shares may be more difficult to sell.
#2 Gold Certificates – Much like other certificate based investment programs, Perth Mint will provide you with the cash equivilent of the gold certificates if you send them in. You will have to allow several days for the cash to clear, but the transaction itself doesn’t require you to find another ‘buyer’, unlike stock markets.
#3 Digital Gold – You can cash out digital gold online via the principal issuing companies website.
#4 Private Ownership – While you can ‘cash your gold!!!’ on the high street, To receive its full value, you will want sell via auction or placement to other investors, which could take several weeks.
(Note – Digital gold is clearly out of the running for being named the ‘best way to hold gold, so at this point we’ll knock it out).
Best Way to Hold Gold: Efficiency
#1 BullionVault. BullionVault takes the top spot for efficiency, with trading commissions of 0.2% – 0.8% to buy or sell and tiny 0.12% annual storage fees.
#2 Physical Gold Exchange Traded Funds – Largest gold fund SPDR Gold Shares has a total expense ratio of 0.4% per year, and will cost around 1% in total broker and market maker commissions to buy or sell your shares, just like any share trade. This should be still much cheaper than taking delivery, storing and insuring gold yourself.
#3 Government Backed Gold Certificates – Perth Mint charges intial fees for buying certificates, but these do not carry annual fees. Minimum transaction is $5,000 (Aus) though.
#4 Derivatives/SpreadBetting – Derivatives and spreadbetting suffer from similar efficiency issues. Both require the ‘rolling over’ of short-term contracts from month to month, incurring commissions (in the form of the bid-ask spread for spreadbetting). Also, derivatives and spread betting are leveraged activities, and so there is a cost of borrowing inherently built into the cost of investing in these products.
#5 Mining Equities – For the same reasons outlined above – mining equities are not a pure play on the price gold, and as such are not an efficient way of investing. However, the extra risks you expose yourself to will theoretically be compensated by a higher expected return of the stock itself. As a result, many investors who want exposure to gold, simply increase their holdings in mining companies for an opportunity to participate in gold price rises, without necessarily increasing their portfolios expenses.
#6 Private Ownership – Buying gold bullion coins and bars from most suppliers (especially for small quantities) will be an inefficient method of buying gold, as these products are usually priced at a markup to the gold spot price. This is equivilant to a large loading fee of a mutual fund. The costs of storage and insurance will be significant, and will eat into your quantites of gold over long period (if you sell gold to run the expenses).
Overall Best Way to Hold Gold
This is a list of the combined ranking of the lists above. The lowest score is crowned as the winner!
BullionVault (Score= 4) – This is why I have chosen to advertise BullionVault to Financial-Expert.co.uk visitors. Visit BullionVault yourself to discover why they’re the world largest private gold investment company.
Physical Gold ETFs (Score = 5)
Government Backed Gold Certificates (Score = 5)
Derivatives (Score = 8 )
Spreadbetting (Score = 9)
Mining Equities (Score = 11)
Private Ownership (Score = 12)
Digital Gold = Not Suitable for Investors.
Naturally if we play around with different criteria, the outcome will differ. Each type of gold holding is ideal for a different type of investor, depending on time horizon, experience, risk tolerance and whether they enjoy personally holding gold. So while the scoring shouldn’t be taken too literally, the reasoning behind the scores will hopefully get you thinking about which investing method matches your individual style. I must also warn that I believe gold is overvalued. I explain my reasons in ‘Is Gold Overvalued?’