Investment - how?

Investors should consider a number of factors when choosing which method of investing in gold is most suitable to them.  Does the investor want to own gold or does he simply want exposure to gold price fluctuations?  Is the investor comfortable with the idea of leverage and margin calls or not?  Does the investor understand the fee structures attendant upon each type of product? 

Regulatory constraints may also restrict access to certain types of investment and this is something else to take into consideration.  These apply regardless of the particular set of reasons driving an investment strategy.

Coins and bars

Bullion coins and small gold bars, for example, which each contain a minimum of 99.5 % fine gold, are appropriate for private investors wishing to buy small amounts. In many countries, including all member states of the European Union, gold purchased for investment purposes is exempt from VAT.

Bullion, which is legal tender in its country of origin for its face value, should not, however, be confused with commemorative or numismatic coins.

Gold accounts

There are two types of gold accounts: allocated and unallocated.

Holding gold in an allocated account is rather like keeping it in a safety deposit box. Specific bars (or coins, where appropriate), which are numbered and identified by hallmark, weight, and fineness, are allocated to each particular investor, who has to pay the custodian for storage and insurance.

Many investors prefer to hold gold in unallocated accounts, which are conceptually similar to foreign exchange accounts. Unless investors take delivery of their gold (usually within two working days), they do not have specific bars ascribed to them. An advantage of unallocated accounts is that investors do not incur storage and insurance charges. However, they are exposed to the credit-worthiness of the bank or dealer providing the service in the same way that they would be if they had any other type of account.

As a general rule, bullion banks do not deal in quantities under 1000 ounces. In this sense, they can be thought of as wholesalers or business-to-business entities. Their customers are institutional investors, private banks acting on behalf of their clients, central banks and gold market participants wishing to buy or borrow large quantities of gold. Major bullion banks are members of the London Bullion Market Association and their contact details are available on the "List of Members" section of the LBMA website.

However, other opportunities exist for investors wishing to open gold accounts representing less than 1000 ounces. The minimum investment requirement of the Perth Mint Certificate programme is USD 10,000.00 (approximately 32 ounces), while the minimum investment requirement for Gold Pool Accounts is one ounce. More information about the Perth Mint Certificate Program is available from the Perth Mint and Kitco, an online dealer, as well as other Approved Dealers of the program.

Exchange Traded Funds

The newest way of investing in gold is through exchange traded funds.  Gold is traded in the form of securities on stock exchanges in Australia, France, South Africa, the United Kingdom and the United States. By design, this form of securitised gold investment is expected to track the gold price almost perfectly. Unlike derivative products, the securities are 100% backed by physical gold held mainly in allocated form, and are generically referred to as "exchange traded gold". The securities are all regulated financial products.

Exchange traded gold provides retail and institutional investors with an efficient and cost-effective way to invest in gold.  It aims to overcome the existing barriers to gold as a practical asset and trading tool.  For many investors, costs associated with buying and selling the securities are expected to be less than the costs associated with buying, selling, storing and insuring gold bullion in a traditional allocated gold bullion account.  Furthermore, exchange traded gold can be traded as easily as any other security listed on a stock exchange.

Financial advisors and other investment professionals can provide further details about these products.

Futures and Options

Investors seeking leverage may prefer futures contracts or options. Both operate like their counterparts in other marketplaces. The price of gold futures is determined by the market's perceived value of what the carrying costs ought to be, and consequently is typically higher than the spot price.

Both futures and options can be traded through brokers on regulated commodity exchanges, such as the New York Mercantile Exchange Comex Division, CBOT and TOCOM.   Gold futures are also traded in India.  Forward contracts are agreements to exchange gold at an agreed price at a future date, and can be used to either manage risk or for speculative purposes.

These contracts are negotiated directly with counterparts and consequently, unlike standard futures contracts, are tailor made. However, unlike futures which are guaranteed by the exchanges on which they are traded, there is a degree of counterparty risk with forwards.  They are also less liquid. Warrants give investors the right to buy gold at a specific price on a specific day in the future. Investors pay a premium for this right. Warrants are usually leveraged to the price of the underlying asset, but gearing can be on a one-for-one basis.

Gold certificates

Gold certificates are a type of warrants issued predominantly by banks in Germany and Switzerland.  Some certificates are traded on exchanges, others are available only "over the counter".  Some represent one for one ownership of gold held by the issuing bank on the client's behalf, whilst others are closer to derivative type products like options, offering clients geared exposure to the gold price.  Given the range of products to which the term "certificates" is applied, investors should check structures carefully with their advisors before committing funds.

Gold-linked structured products

This type of investment, which typically entails some kind of fixed-income with limited exposure to the gold price and some degree of principal protection, is available over the counter (is not exchange-based) to larger scale investors.

Derivative in nature, this type of product is extremely flexible and can be tailored to suit the requirements and outlook of individual clients (subject to a substantial minimum investment).  Typically, structured notes use part of the investment funds to purchase put or call options, depending on whether the product is designed for gold bulls or bears. The balance is investment in fixed income products to generate a yield.  

Gold mining equities

Although investment in the shares of gold mining companies do not strictly represent investment in gold bullion per se, the conventional wisdom is that the shares of many mining companies represent geared exposure to the gold price because the intrinsic value of these companies derives at least in part from the gold they are entitled to mine in the future. 

If the gold price rises, the profits of the gold mining company could be expected to rise and as a result the share price may rise. Investing in equities generally augurs benefits such as dividend yields, a type of return that gold itself cannot provide (returns on gold being essentially derived through capital gain). 

But investing in gold mining equities is not the same as investing in gold and investors should take a number of factors into account in addition to the outlook for the yellow metal: 

Has the company already sold its future gold production, through forward sales?

Is the company already producing gold, or is it mainly exploring for gold?

Does the company make a profit?

How much many years of ore reserves are left in the mines before they have to be closed down?

What PE ratio and dividend yield does the company have now and in the following years?

Are the mines subject to political or economic risks?

Gold investment funds

A number of collective investment vehicles specialise in investing in the shares of gold mining companies. The term "collective investment vehicles" as used here should be taken to include mutual funds, open-ended investment companies (OEICs), closed-end funds, unit trusts, and so on.

A wide range of such funds exists and they are domiciled in a number of different countries. These funds are regulated financial products and as such it is not possible to go into any details on specific funds.

Funds are likely to differ in their structure - some may invest simply in mining stocks, some may invest in companies that mine minerals other than gold, some may invest in futures as well as mining equities and some may invest partly in mining equities and partly in the underlying metal.