Thursday, 5 August 2021

How to Trade Gold

How to Trade Gold
13 Feb

Gold has long been thought of as a store of value. The precious metal seems to have a certain mystique about it, with gold jewelry and bars of gold giving off an aura of wealth. At one point, the U.S. dollar was linked to the price of gold via the gold standard. This relationship started in the 1830s and lasted until 1971. Some historians say the gold standard contributed to the Great Depression.

Gold as an investment is a bit of a different endeavor versus more traditional investments in stocks and bonds. Here we will discuss some key aspects of investing in gold and how to get started trading it.

What makes gold such a popular investment

Gold has long served as a hedge against rising inflation and a declining U.S. dollar. It also serves as a haven in times of economic and political turmoil.

“Gold, along with silver and other ‘tangible’ assets like real estate, protect wealth as currency depreciation erodes purchasing power,” said Brien Lundin, editor of Gold Newsletter and CEO of the New Orleans Investment Conference. “The prices of these tangible assets tend to rise as the currency they’re priced in erodes. But historically — for about 5,000 years, in fact — gold has stood above all other options as the standard of wealth preservation as currencies devalue.”

Factors that impact the price of gold

Multiple factors affect the price of gold:

  • Supply and demand: Gold is a commodity and these factors play a key role in determining the price just like any other commodity.
  • Inflation: Gold is often seen as a hedge against inflation.
  • Currency fluctuations: Gold is denominated in U.S. dollars and movements in the dollar will impact the price of gold.

Getting started: 4 ways to buy and sell gold

Buying and selling gold is not just limited to one format. There are several ways to trade gold and use it as an investment.

According to Lundin, there’s a wide spectrum of gold investments, ranging from physical metals — bars and coins, to securitized physical holdings — ETFs, futures and options, mining stocks, and more. “And within each category, there are many options as well,” said Lundin.

1. Physical gold

Several forms of physical gold can be owned — gold bars and coins are two of the most popular ways available. When buying physical gold, you will want to check the current spot price of gold to ensure that you don’t pay too much of a premium for the gold.

Also, try to ensure that you are buying the physical gold from a reputable gold dealer. Gold can be purchased online and at local jewelry stores. The U.S. Mint has a site to help you locate a gold dealer in your area. These dealers are checked against BBB reports, but the Mint does not make any guarantees.

You can also buy gold coins directly from the U.S. Mint.

It’s also important to ensure that any gold you own is stored in a safe place. This might be a bank safe deposit box or if it is a small quantity you could store it at home. You want to be sure the gold is stored securely to avoid theft, just like any other valuable.

2. Gold futures

Futures contracts trade on exchanges like the Chicago Mercantile Exchange and allow the holder the right to buy gold in a specified quantity for a specified period of time.

Trading gold futures contracts on an exchange like the Chicago MERC requires an initial deposit called a margin to open a trading account. Each day that you hold the contract, it will be marked-to-market based on the value of the amount of gold each contract controls.

If the value of your futures account drops below a specified amount, called a maintenance margin, you will either need to add additional cash or liquidate your futures position.

Typically, futures contracts do not end with the contract holder taking physical delivery of the underlying quantity of gold upon expiration. Settlements are made in cash. Trading gold futures should generally be thought of as a way to speculate on the price of gold.

That said, futures contracts can occasionally result in the physical delivery of the metal. This process will vary a bit based on the exchange involved.

3. Gold ETFs and mutual funds

Gold exchange-traded funds (ETFs) are funds whose underlying portfolio consists of physical gold. Investors in these ETFs don’t have to worry about the storage of physical gold, tracking futures contracts or maintaining sufficient levels in their account. Gold ETFs are traded on exchanges just like other ETFs that invest in stocks, bonds and other instruments.

Some popular gold ETFs include:

  • SPDR Gold Shares (GLD): The underlying assets of the fund consist of gold bullion stored in a vault.
  • iShares Gold Trust (IAU): This non-standard trust is also backed by physical gold bars held in a secure vault.

According to ETF Database, GLD and IAU had just over $33 billion and just under $12 billion in assets as of January 2019, respectively. The next largest gold ETF had about $860 million in assets, according to their data.

As far as mutual funds, there are a number of funds that are in the precious metals space. Many of these funds invest in stocks of companies in the gold and precious metals space. Examples of a few popular mutual funds in this space include:

  • Fidelity Select Gold Portfolio (FSAGX): This fund invests in gold stocks as described in the fund’s fact sheet by “investing primarily in companies engaged in exploration, mining, processing, or dealing in gold, or to a lesser degree, in silver, platinum, diamonds, or other precious metals and minerals.”
  • American Century Global Gold Fund (BGEIX): This fund invests in “total return primarily through holdings in companies engaged in mining, processing or distributing gold or other precious metals throughout the world,” according to the description on the fund company’s site.

Note in both cases, these funds invest in gold stocks as well as the stocks of other firms in the precious metals space versus holding gold in reserve as with the ETFs described above. The underlying stocks held in the portfolios of these mutual funds and those of other similar funds are sensitive in large part to the price of gold, but again are not a direct investment in the commodity.

4. Gold-mining stocks

Gold-mining stocks are another popular way for investors to get exposure to gold. These are stocks of companies who mine the metal and participate in other stages of the process.

An example of two well-known gold mining stocks:

  • Barrick Gold Corporation (ABX): Barrick Gold is a leading gold mining company.
  • Royal Gold, Inc. (RGLD): Royal Gold makes its money from royalty and streaming agreements with major gold-mining companies. As a result, they don’t need to invest in heavy equipment and other mining tools like pure gold miners do.

These and other gold mining and processing stocks will track the price of gold to a point but will also rise or fall based on the underlying fundamentals of the companies much like the stocks of companies in various industries.

Tips for avoiding potential pitfalls

“There are lots of potential pitfalls in this sector, which is why it’s so important for an investor to take the time to educate themselves,” said Lundin who shared some areas of caution for investors considering gold. “In buying physical gold or silver bullion, for example, steer clear from rare coins (numismatics) or limited-edition modern coins. These areas are for hobbyists, and no one makes money from them without it first becoming a hobby that they avidly follow.”

“Also, again, check prices, and if you’re buying or selling to a coin dealer, make sure they’re a member of the Professional Numismatists Guild,” Lundin added. “One other good idea: If you’re selling grandpa’s coin collection to a dealer, do some research on the web and check with at least three dealers. And don’t ask them, what will you pay me for these coins? Instead, ask what are they worth?”

Bottom line

Gold is a popular and often misunderstood investment. It has long been considered a store of value and serves as a hedge against inflation and currency fluctuations. Gold investing, in its various formats, can be a potentially lucrative addition to an investor’s portfolio as long as the opportunities — as well as the risks — are well understood.

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