A Complete Guide to Investing in Gold

Why invest in gold and what are the pros and cons of different gold investment vehicles.

Gold may be the asset that arouses more passion than any other investment. On one side are individuals who are skeptical of gold like Josh Brown, CEO of Ritzholtz Wealth Management. He said on The Indicator from Planet Money podcast that “Gold is getting a little outdated. A lot of younger investors who want an independent, government-free store of wealth now tend to gravitate not to gold, but to cryptocurrency, like Bitcoin.” He also said gold’s performance has been “embarrassing.”

On the other side are those who are bullish on gold such as Jim Grant, founder of Grant’s Interest Rate Observer. He wrote in Barron’s, “Gold which is probably never traded at 0, not in millennia, [is] a store of value. Gold explains itself. One look tells you it’s valuable. You don’t need a computer server, electrical outlet, or instruction manual like you would with cryptocurrency.”

In this guide, we explore reasons to own gold, how the precious metal has performed, and what are the best ways to invest in gold. 

Why Invest In Gold

There are three primary reasons investors own gold:

1. As an inflation hedge
2. As a safe haven
3. Because gold is under-owned and scarce

Gold as an Inflation Hedge

Since the late 1960s, gold has increased on average by 5.7% per year, according to data from Ned Davis Research. That performance is well above the rate of inflation, which is why many individuals own gold as an inflation hedge. 

Yet, gold has gone through long stretches when it has not kept pace with inflation. An investor who bought gold in 1980, when gold was selling for close to $1,900 per ounce in today’s dollars has lost money on an inflation-adjusted basis. 

The problem with holding gold as an inflation hedge is its returns are volatile. Some years gold does better than inflation while other years gold lags inflation. 

Claude B. Erb and Campell R. Harvey studied the historical performance of gold as an inflation hedge and reported their findings in a paper titled The Gold Dilemma. They concluded, “If gold were a perfect short-term inflation hedge, then the real price of gold should be constant and exhibit no real price variability.”

Erb and Harvey gave an example of a Brazilian investor who bought gold in 1980 as an inflation hedge. Over the next 20 years, Brazil had an average annual inflation rate of about 250%.

What did gold return during that time? Gold lost 70% on a real basis, as quoted in the Brazilian Real. Gold performed better than holding cash denominated in the Brazilian Real, which lost close to 100% of its value. Still, gold was by no means a good inflation hedge because 1980 was a cyclical peak for gold. 

“If gold were a perfect short-term inflation hedge, then the real price of gold should be constant and exhibit no real price variability.” – Claude B. Erb and Campbell R. Harvey

Inflation-indexed bonds, such as TIPS and Series I Savings bonds, are much better inflation hedges because their performance is tied directly to inflation. You can learn more about investing in inflation-indexed bonds in this helpful guide. 

You can also learn what causes inflation and other ways to protect against it in this guide.

Gold as a Safe Haven

A safe-haven asset is something that performs well when there is a spike in geopolitical risk that causes riskier assets such as stocks to fall in price. The price of the safe-haven asset should be stable or increasing during periods of turmoil. Gold has had mixed results as a safe-haven asset. During some bouts of economic and political disorder, gold has risen in price while at other times it has fallen in price. 

A safe-haven asset also needs to be accessible. Gold has been illegal to own at times, such as in the U.S. for much of the twentieth century. Governments have also confiscated gold, which led holders to hide it or try to smuggle it out of the country. 

One benefit of gold is it is imperishable. Gold cannot be destroyed. Individuals have valued its beauty and durability for thousands of years. While the price of gold can fluctuate significantly, its long history of ownership suggests there will always be some demand for gold as a safe-haven asset. 

Gold is Under-Owned

A third reason that individuals and institutions own gold is they believe the precious metal is under-owned. Under-owned means that demand will increase in the future if conditions change such as confidence in governments and central banks wanes.

The total amount of gold in the world is just under 200,000 metric tons. Jewelry comprises about half the usage, according to the World Gold Council. Private investors own just over 20% of the gold supply. Central banks and governments own just under 20%.

For 2019, the World Gold Council estimated the supply of gold increased by 2% to 4.8 metric tons while demand was 4.4 metric tons, down 1% from 2018. 

In order for the gold price to rise, demand to own gold, particularly by investors, needs to increase.

Warren Buffett, in the 2011 Berkshire Hathaway Shareholder Letter, wrote, “What motivates most gold purchasers is their belief that the ranks of the fearful will grow.”

What do gold investors fear? That unconventional monetary policy by central banks, such as their willingness to buy non-investment grade bonds, will lead to a lack of confidence in fiat currencies that causes their value to drop relative to gold.

Investors also fear overindebtedness by governments and corporations will keep interest rates so low that other asset classes, such as gold, will become more attractive. Gold doesn’t generate any income, so when interest rates are high, there is an opportunity cost to holding gold. Investors give up income when they shift from bonds to gold.

“What motivates most gold purchasers is their belief that the ranks of the fearful will grow.” – Warren Buffett

When interest rates are low or even negative, the case for gold is more compelling because there is less of an opportunity cost

Hedge fund founder and author Ray Dalio wrote, “I think that the paradigm that we are in will most likely end when real interest rate returns are pushed so low that investors holding the debt won’t want to hold it and will start to move to something they think is better. Which asset will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold.”

Jim Grant wrote, “Gold’s price is the reciprocal of the world’s faith in central banks. If you think something might not be right with the world, in terms of the dominance of central banks, perhaps you should own some gold.”

Gold is a Speculation

Gold doesn’t generate any income, so it is difficult to determine its correct price. You can’t say gold is too expensive or too cheap. It’s worth whatever individuals and institutions are willing to pay for it. 

In my book, Money For the Rest of Us: 10 Questions to Master Successful Investing, I share how to tell the difference between a speculation, an investment, and a gamble. 

An investment is an asset that has a positive expected return, usually because there is an income component, such as dividends, interest or rent. A speculation is an asset where there is some disagreement about whether the return will be positive or negative. A gamble is something with a negative expected return.

Gold is a speculation because there is no income and significant disagreement over its future return, as evidenced by the quotes by Josh Brown and Jim Grant at the beginning of this article.

Speculations are not harmful. They are just not as predictable as investments, which means investors should allocate less money to speculations than to more traditional income-generating investments like stocks, bonds, and real estate. 

Gold can play a role in an investor’s portfolio because it provides exposure to one of the oldest real assets in the world. Gold’s price is volatile, so it has not always been the best inflation hedge or safe haven. Yet, gold’s scarcity, durability, and beauty provide some assurance that individuals and institutions will value it in the decades ahead.

I keep about 5% of my net worth in gold because I believe over the long-term it will outperform inflation and act as a safe-haven, even though it will go through long stretches of underperformance. Gold definitely outpaced inflation and most asset classes in 2020 as it returned over 20% in U.S. Dollar terms.

 

How to Invest In Gold

The five primary ways to own gold are:

1. Physical gold coins or bars
2. Gold ETFs and Trusts
3. Gold futures 
4. Gold mining stocks
5. Gold jewelry

How to Buy Physical Gold Coins and Gold Bars

The most satisfying way to own gold is to buy gold coins or bars. Doing so allows you to experience gold’s beauty. To feel how heavy and durable gold is. 

The challenge with owning physical gold coins or bars is the owner has to figure out where to store it. Many investors store their physical gold in a home safe. Others store their gold in a safe deposit box at a bank.

Another option is to pay a custodian or depository to store the physical gold. Annual storage fees at a depository are about 0.12% to 0.50% of the gold’s value on an annual basis.

OneGold is an example of a custodian that will hold physical gold. It charges 0.12% per annum for gold storage.

The difference between gold bars and gold coins is obviously their shape but also their weight. Gold bars can be minted into heavier weights compared with gold coins. Gold investors should always consider the percentage of gold in the piece that they are buying. Some gold bars and coins are 99.9% pure gold, while some coins like the American Eagle are only 91% gold. 

Gold coins are primarily minted in one ounce or one-half ounce coins such as the American Eagle or Canadian Maple Leaf coins. Investors can purchase individual gold coins or buy them in sealed tubes of 20 or more coins. Gold coins often sell for more than the price of the gold they contain due to the collectible value.

When buying physical gold from a dealer, an investor will pay a premium over the spot price of gold. This premium typically ranges from 1% to 5% and represents the handling cost and dealers’ profit. During periods where demand for physical gold is high, gold coins can sell for a premium of 10% or more relative to the gold spot price.

I have purchased the physical gold coins that I own through APMEX using their website. APMEX overnighted the gold, and it arrived in a large blue padded plastic box that looked like a battery case.

Investors can also sell their gold coins and bars back to a dealer such as APMEX. The dealer will pay a discount to the spot price for gold.  

Pros and Cons of Investing In Physical Gold

Buying Gold ETFs 

Gold ETFs like the iShares Gold Trust (IAU) the SPDR Gold Trust (GLD) and the SPDR Gold MiniShares Trust (GLDM) are the most convenient way to purchase gold. These ETFS are bought and sold through a broker, often on a commission-free basis. An ETF is a public, pooled, indirect investment vehicle. You can learn more about different investment vehicles in this guide.

An investment in a gold ETF Trust represents a fractional interest in the trust’s assets. These gold trusts own physical gold that is held by a custodian. The trusts have annual expense ratios of 0.18% to 0.4% to cover management fees and other administrative costs. The SPDR Gold MiniShares Trust (GLDM) has the lowest expense ratio of the gold ETF trusts with an expense ratio of 0.18%.

ETFs trade on an exchange, which means their price can differ from the net asset value of the ETFs holdings. That is also the case for a gold ETF. These ETFs can sell for a premium or discount relative to the net asset value. 

An ETF’s net asset value or NAV is calculated by taking the value of the ETF’s assets, including cash, subtracting the liabilities or debts the ETF might have, and dividing by the number of shares outstanding.

Institutional investors, known as authorized participants, work directly with the gold trust sponsor to exchange baskets of ETF shares for gold and vice versa to keep the price of the gold ETF close to the net asset value.

The downside to owning gold through an ETF is the investment is still linked to the financial markets. There isn’t a way to access the physical gold. If financial markets are shut down for some reason, investors are not able to sell their interest in the gold trust. 

An investment in a gold ETF trust is effectively a paper asset whose performance is tied to gold. Still, investing in an ETF trust is the simplest way for most investors to get gold exposure. While most of my gold is in physical coins, I also own a position in the iShares Gold ETF (IAU).

Gold ETF Examples

Here are some examples of ETFs that invest in gold.

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Pros and Cons of Investing In Gold ETFs

Sprott Physical Gold Trust and Taxes on Collectibles

The Sprott Physical Gold Trust (PHYS) is a closed-end fund managed by Sprott Asset Management LP, a Canadian natural resources asset management firm. 

The trust owns physical gold bullion in the same manner as the iShares Gold ETF and the SPDR Gold Trust. The Trust’s annual expense ratio is 0.45%. 

The Sprott Physical Gold Trust differs from gold ETFs in that there is not an ongoing mechanism to keep the price of the fund in line with its net asset value. The Sprott Physical Gold Trust is similar to other closed-end funds in that it has gone through periods when it has sold at a premium and at a discount to the net asset value. You can learn more about investing in closed-end funds in this helpful guide.

One advantage of the Sprott Physical Gold Trust for U.S. investors compared to gold ETFs is the tax treatment. U.S. taxpayers who sell physical gold or gold ETFs for a profit are potentially subject to 28% collectibles capital gains tax rate, which is higher than regular capital gains tax rates.

The Sprott Physical Gold Trust is classified as a Passive Foreign Investment Corporation under U.S. tax rules. That means U.S taxpayers who realize a long-term gain when selling their Sprott Physical Gold Trust holdings are taxed at long-term capital gains tax rates instead of at the 28% maximum collectibles tax rate.  

Only U.S. taxpayers whose marginal tax rate on ordinary income is higher than 28% pay the collectibles tax rates. The tax rate on collectibles like gold is the lower of the marginal ordinary income tax rate or the 28% collectible tax rate. For example, U.S. taxpayers whose marginal tax rate on ordinary income is 22% would pay a 22% tax rate on net capital gains for selling gold and other collectibles.

Unlike gold ETFs, the Sprott Physical Gold Trusts allows holders to redeem shares for physical gold monthly. Unfortunately, the minimum redemption amount is prohibitively high for most individual investors. Shareholders who wish to redeem for physical gold must take delivery of at least one London Gold Delivery Bar which weighs between 350 and 430 troy ounces. 

Buying Gold Futures

A gold futures contract is an agreement to buy or sell gold at a future date. A speculator buys or goes long a futures contract if she expects gold to rise and price. She sells or goes short the futures contract if she expects gold to fall in price.

Gold futures contracts allow investors to get exposure to gold without putting up much capital. That means the positions are highly leveraged so they can be volatile.

For example, a speculator in the E-micro gold futures contract only has to put up about $1,000 in a margin account to establish a position in one gold futures contract. The contract size is ten troy ounces. All gold is denominated in troy ounces rather than regular ounces. A troy ounce is equal to 31.1 grams compared to 28.35 grams for a regular ounce. If gold is selling for $1,700 per troy ounce, then the contract value would be $17,000. 

As the gold futures price fluctuates, gains and losses are added to or subtracted from the margin balance. 

The gold futures contract is usually priced higher than the current price for gold, which is known as the spot price. For speculators to earn a profit buying gold futures, the spot price at the time the futures contract expires must be higher than the futures price at the time the investor entered into the futures contract.

Most individuals who participate in the gold futures market close out their trade before the contract expires. E-micro gold futures owners have the option of taking physical delivery. Comex, the contract’s sponsor, won’t send out a 10-ounce gold bar to settle the trade. Instead, Comex will send the futures contract owner an Accumulated Certificate of Exchange, which represents a 10% ownership in a 100-troy ounce Gold bar held in the form of a COMEX gold warrant. 

One advantage of investing in gold futures contracts instead of owning physical gold or a gold ETF is the favorable tax treatment. Gains on gold futures contracts are taxed at 60% the long-term capital gains tax rate and 40% short-term taxable gains tax rate. For many individuals, that combined tax rate is lower than the 28% collectible tax rate.

Most individuals will find it simpler to make long-term investments in gold via an ETF, but gold futures contracts are a viable option for those that want to speculate on gold’s shorter-term price movements. 

Pros and Cons of Investing In Gold Futures

Investing in Gold Mining Stocks and Funds

There are just under forty publicly traded gold mining stocks that generate the majority of their revenue from gold mining, according to the holdings in the MSCI ACWI Select Gold Miners IMI Index.

Gold mining companies earn a profit if their production costs are lower than the spot price of gold. Those production costs average about $1,000 per ounce, according to John Hathaway, portfolio manager of the Sprott Gold Equity Fund. The oil price contributes to those production costs as gold mining uses fuel-intensive heavy equipment. 

Historically gold mining stocks have lagged the overall price of gold by 1.5% a year going back to 1974, according to data from Ned Davis Research. Gold miners significantly underperformed the price of gold on an annualized basis since 2009, but have outperformed the past two years. 

Investors can purchase individual gold mining stocks or invest via an ETF or actively managed gold mining mutual funds. 

Given the historical underperformance of gold miners compared with the price appreciation in gold bullion, investors are typically better off investing in gold directly unless they believe gold mining stocks are significantly undervalued. 

Gold Miner ETF Examples

Here are some examples of ETFs that invest in gold miners.

The following are affiliate links, if you click and make a purchase we may earn a commission at no additional cost to you.

Gold Jewelry

Individuals can also invest in gold by owning gold jewelry. This is the least effective way to invest in gold because the cost of the jewelry typically exceeds the value of the underlying gold. There is a high markup to compensate the jewelry designer and jeweler.

Conclusion

Individuals have a number of ways to invest in gold. The choice of which gold vehicle depends on the investor’s time frame and the reason for owning the gold. Those who are worried about economic and political disorder might prefer to own physical gold because it is not a paper asset tied to the financial markets. More short-term-focused traders might prefer gold futures due to the leverage and favorable tax treatment. Individuals who want the simplest way to buy gold will lean toward owning a gold ETF. Finally, more active investors that like to research individual companies might prefer to own gold mining stocks.

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