Investing in gold is a core strategy for many investors. First, gold can serve as a safe haven and a hedge against inflation. Simply put, the price of gold tends to rise when investors believe that the value of currency is going to fall.
Another reason that investors turn to gold is to offset volatility in the market. In general, gold prices move inversely to the broader market. That is, when the broader market goes down, gold prices go up.
That’s why many investors look to invest in gold. And one way to do that is by investing in gold stocks. This article will give investors an overview of how to invest in gold stocks. First, we’ll explain how the price of gold is tied to monetary policy and why some investors may want to invest in physical gold.
The article will also describe the different types of gold funds that exist and the factors you should consider when choosing gold stocks. And for investors who are more comfortable with speculating in options, we’ll touch on the pros and cons of trading gold on the futures market using options contracts.
What is the Role of Gold in Monetary Policy?
Today, gold doesn’t play a significant role in monetary policy, but that wasn’t always the case. Until the 1930’s, the United States as well as most developed countries operated on the Gold Standard. This means that the value of a country’s currency is directly linked to gold.
When countries conducted monetary policy using the gold standard, they converted paper money into a fixed amount of gold. This set a fixed price for gold and countries would buy and sell gold at that price. Countries that were running trade surpluses increased their gold supply as payment for their exports. Conversely, countries running a trade deficit saw their gold supply shrink as they received imports.
The world wars of the early twentieth century were the catalyst for many countries moving away from the gold standard. And in 1944, the Bretton Woods Agreement effectively ended the gold standard. However, it wasn’t until 1971 that the United States announced it would no longer exchange gold for U.S. currency.
Over Time, Gold Increases in Value
However, once its price was no longer fixed, the price of gold has expanded more than 46 times with a compound annual growth rate (CAGR) of about 8%.
This concern goes back to investor’s concern over the value of the U.S. dollar. For example gold prices soared in the aftermath of the financial crisis. The United States Federal Reserve Board (i.e. The Fed) began a program of quantitative easing that flooded the stock market with liquidity. While economists will debate the merits of this policy for decades, there’s no question that it devalued the U.S. dollar and caused gold to climb.
In fact, in September 2011, the spot price of gold soared to $1,900 an ounce. And in 2020 in the aftermath of the Covid-19 pandemic gold prices approached these record levels again. However, the larger story is that gold has never fallen back to its 1971 level. That makes gold one of the most practical investments you can make.
How Can Investors Purchase Gold?
Today, investing in gold has never been easier, but it does require some research. The most common way for investors to buy and sell gold is by buying the physical metal itself. This is frequently done by buying gold coins, but it can also mean buying actual gold bullion.
This approach has its drawbacks. Specifically gold can be expensive. At the time of this writing, an ounce of gold is trading for over $1,800 an ounce. That’s almost three times the price of one share of Tesla (NASDAQ:TSLA). Plus, physical gold also should be stored and insured. And taking possession of physical gold usually involves transaction fees of some sort.
With this in mind, investors can invest in other asset classes tied to the price of gold. One of these popular alternatives is exchange-traded funds (ETFs). Another option is to invest in gold stocks.
How to Invest in Gold ETFs
ETFs mirror the price movement of gold without the obstacles that can come from the cost (and peripheral obstacles like storing and insuring) associated with buying gold directly.
Just how attractive has it become to invest in gold ETFs? According to Gold.org, in the first five months of 2020, investors bought into gold ETFs at a record pace. Through May 31, investors bought $33.7 billion worth of gold ETF shares.
Shares of an ETF can be bought and sold throughout the trading day just like shares of stock. This is a crucial difference between an ETF and a mutual fund. Since the price of gold can move rapidly in either direction (and sometimes it can make large moves), ETFs are becoming more attractive for investors.
There are many mutual funds and exchange-traded funds (ETFs) that move with the price of gold. When choosing to invest in gold stocks via an ETF or mutual fund, investors have options. One is to find a fund that invests in the metal itself. One such example is the SPDR Gold Shares ETF (NYSE:GLD). This fund is the oldest, and largest, physically backed gold exchange traded fund (ETF) in the world.
One share of the ETF is valued at one-tenth the spot price of gold. At the time of this writing that would be about $180.
The other option is to find a fund that invests in the stocks of physical gold as well as into gold mining companies. These funds may have price movement that is more volatile than an investment in the physical metal itself. Plus, mining companies are subject to geopolitical or environmental concerns that will not affect the cost of physical gold.
As is the case when you buy any mutual fund or ETF you should pay attention to the expense ratio (i.e. the annual fee) charged by the fund. The average expense ratio for gold ETFs is approximately 0.65%.
Another factor to consider is the five-year return of the ETF. This is particularly true if you are investing in a fund, such as the GOLD fund, that is tied directly to the physical metal. Roughly speaking the returns should approximate the movement of gold over that period.
How Do You Invest in Gold Stocks?
Investing in gold stocks is less expensive and offers more liquidity as a way to get involved with precious metals. However, gold does not exist as a company that you buy shares of. Instead when you hear the words “gold stocks” it means you are directly buying shares of a mining company such as Barrick Gold (NYSE:GOLD) or you are buying into a mutual fund or exchange-traded fund (ETF).
When you invest in a mining stock, you’re not investing directly into physical gold. And while it’s true that shares of a mining company should have a correlation to physical gold, the correlation is often a loose one. This is because mining companies have opportunities and challenges that are unique to their sector.
Also as corporations, they have an obligation to their shareholders. While this can sometimes affect capital growth, many mining stocks do pay a dividend which can make them a desirable addition to a value investor’s portfolio. For example Newmont Corporation (NYSE: NEM) pays a dividend yield of 2.74%.
How to Invest in Gold through Options Trading
In recent years, more experienced investors are trading options on physical gold. This is because options trading is a way to, potentially, make a profit while putting less capital at risk.
Options trading means trading in gold futures. A futures contract is traded on an exchange. Buyers and sellers negotiate a specific quantity and price for gold at a specific date.
When you buy an option you are buying the right, although not the obligation, to buy or sell a specific equity at the option price. Essentially you’re betting on price action to occur in a specific direction. If you’re right, it can be very profitable. If you’re wrong, you’re simply out the premium you paid to buy the option.
Investors can choose to take a long or short position in gold. For those unfamiliar with options trading, a long position means an investor is buying gold with the expectation of gold prices rising. In this case, the investor is looking to buy gold at a lower price. By contrast a short position is taken when an investor is looking to sell gold in anticipation of price falling. In this case, the investor is selling gold but intends to cover it later at a lower price.
While this is a different process than buying shares directly, some investors find it to be a more efficient way to trade gold. ETFs come with management fees and taxes on capital gains. Plus regardless of if the fund is actively or passively managed, every ETF has a fund manager that makes decisions on the investor’s behalf.
By contrast, trading futures avoids all of that. And because most investors can use margin to trade, every $1 can represent up to $20 of physical gold.
Trading gold futures is often used as a hedging strategy against the volatility of the stock market or against a weak dollar. Trading gold using options is also a way for speculators to invest in gold without having to have physical gold in their possession.
Some Final Thoughts on Investing in Gold Stocks
For many investors, precious metals are a constant in their portfolio. Others move in and out of gold and other metals as conditions warrant. That’s one reason why gold stocks can be an appealing option. Rather than hold the physical asset, investors can trade shares just like they do for other equities in their portfolio.
And if investors don’t want to trade in the options market, they can choose to invest in the security of an exchange-traded fund (EFT) or mutual fund. While these investments are not going to hold as much value for investors as holding the physical asset, they are a low cost way of maintaining a position in gold without the need to hold physical bullion.
However you decide to invest in gold, it’s important to understand that while gold is known as a true store of value, it can be volatile. Therefore investing in gold while not at a risk of going to zero does contain a level of risk that may be uncomfortable for risk-averse investors.