How to invest in gold

& is gold a good investment?

Whenever the economy gets turbulent, the fans of investing in gold emerge. They’re sometimes called “goldbugs” and will shout from the rooftops that the world is doomed, and that the only logical investment is gold. They usually make at least a few good points, and their arguments can sound quite convincing.

But, is gold all it’s made out to be, and if so, what’s the best way to invest in it?

Background – what makes gold valuable?

In ancient times, before the first coins were developed, trading was just bartering with items you had for items you needed – maybe you’d swap a few eggs for some bread? In time, coins and then more formal currencies stopped the need for this and provided a convenient way to store value.

Gold doesn’t corrode and can be melted over a low flame. It’s hard to dig gold out of the ground – and the more difficult something is to obtain, the higher it is valued. These features, and gold's unique appearance, led to its use in jewellery and early coins.

The Gold Standard

As formal ‘paper’ currencies evolved, major world currencies were backed by gold in a system known as the Gold Standard. Under the Gold Standard, you could ask a bank to convert your paper money to gold at the legal rate, whatever that might be. For the government to print more money, they had to have the gold to back it.

Britain stopped using the Gold Standard in 1931, and the U.S. mostly followed suit in 1933 then abandoned the remnants of the system in 1973. The Gold Standard had pros and cons, and eventually the troubles with it led to every single nation abandoning the system.

The modern system

However, many people dislike the modern world’s monetary system because it's based on fiat currency. That is, a dollar is worth an arbitrary amount because a government authority says so - it's not based on anything concrete. A key drawback of this is that the government can add and remove cash from the money supply at will, which affects the dollar's value.

In contrast, gold is often viewed as a “safe-haven” investment. If paper (fiat) money were to suddenly become worthless in some sort of drastic economic catastrophe, the world would have to fall back on something of value to enable trading to occur. This is one of the reasons that investors tend to push up the price of gold when financial markets are unsettled – and the goldbugs always seize the opportunity to try and sell us all gold!

Does gold have intrinsic (real) value?

Some fans of gold like it because they say it has intrinsic value. Goldbugs would have you believe that when disaster strikes that paper money will be worthless and we'll all be trading in gold. Because of its intrinsic value, gold will be a form of currency.

The problem is, this doesn’t sound that logical. Let's say you’re in a post-apocalyptic environment filled with looters or aliens. In that case, you probably won’t care about a gold bar or some gold jewellery – it'll be just as worthless (or as valuable) as paper money. Why? - Because, gold is fundamentally a fiat currency too. That is, people have assigned it an arbitrary value. That value vanishes in a crisis, just as the value of paper money does. In this imaginary post-apocalyptic situation filled with looters or aliens, you’d more than likely want something real that has practical value, something like a carton of eggs, some seeds, a cow, diesel to run a generator or vehicle, or some shells for your shotgun.

In other words, assigning value to gold is just as arbitrary as assigning value to anything else. If a real catastrophe strikes, gold probably isn’t going to save the day.

How well does gold hold its value in a downturn?

Despite the comments above, this is one of the key strengths of gold as an investment – it’s a diversifier whose price should move differently to the price of other assets and inflation.

While past returns are no guarantee of future results, gold nearly always goes up in price when investment markets fall. This makes sense when you think about it:

• Shares (stocks) benefit from economic growth and stability while gold benefits from economic distress and crisis.
• So, if the share market falls, fear is usually high, and investors typically seek out the safe haven of gold. If shares drop in value or hit a bumpy patch, the perceived need for gold from mainstream investors can increase.

Ways to invest in gold

If you think that a little gold could be a welcome addition to your overall portfolio, take your pick from the following ways to invest in it:

• Coins, bars, or bullion. Some people like the comfort of having the ability to hold their investment in their hands. Aside from brokerage (buying-related fees, which are usually a mark-up of 5-8%) a key drawback of this approach is storage: you’re going to have to pay someone to store your gold, or store and insure it yourself – maybe buried in the back yard! Also, skip collectible coins, which can carry a big premium for rarity.
• Jewellery. The retail mark-ups in the jewellery industry make this a bad choice for investing in gold. That said, eagle-eyed buyers with experience in the field sometimes report that second-hand jewellery can be found at prices below the meltdown value. Of course, this will be costly if you don’t know what you’re looking for, and with this approach you’ll still need somewhere to store it.
• Gold focussed exchange traded funds (ETFs) and managed funds. There are a range of gold-focussed specialist funds. These are sometimes called “paper gold” as you, the owner, can avoid the storage issues present with bullion etc. The high initial buying, storage, and even selling charges that go into owning gold jewellery, bars, or coins gives another edge to these low-cost funds.
• Indirect. Buying the shares of mining companies is another low-cost and simple way to invest. The prices of mining companies tends to follow the prices of the commodities on which they focus; however, because miners are running businesses that can expand over time, investors can benefit from increasing production. This can provide upside that owning physical gold never will. In addition, because of the nature of mining itself, most gold miners produce more than just gold. However, running a business also comes with the accompanying risks. Mines don't always produce as much gold as expected, workers sometimes go on strike, there are environmental concerns, and disasters like a mine collapse or deadly gas leak can halt production and even cost lives.

There's no perfect way to own gold: each way comes with trade-offs.

How much should you invest in gold?

Gold can be a volatile investment, so if you do decide to invest in it, you shouldn't put a large amount of your assets into it – it certainly shouldn’t be a core part of any investment mix. At most, 5% of your overall portfolio should be plenty.

But before you invest in gold, let us cover just one more thing…

Is gold a good investment?

A major issue with a direct investment in gold is that there's no growth potential. An ounce of gold today will be the same ounce of gold 100 years from now – unless you’re a jeweller and can manufacture the gold into something more valuable. This is one of the key reasons famous billionaire investor Warren Buffett doesn't like gold - it is, essentially, an unproductive asset. It’s also pricey, take a look at what Buffett had to say in a 2010 interview:

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet [20 metres approx.] on a side… Now for [the price of] that same cube of gold… you could have all the farmland in the United States, you could have about 7 ExxonMobil’s, and you could have a trillion dollars [US] of walking-around money… And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally… Call me crazy, but I’ll take the farmland and the ExxonMobil’s.”

The bottom line – how to invest in gold

Investing in gold is one of those topics that tends to inspire passionate debate. As with any investment, there are advantages and disadvantages to weigh up before investing in gold. There is also no one-size-fits-all answer to questions like:

1. Should you invest in gold?
2. If so, how you should invest in it?
3. How much of an investment should you make?

Of course, given the high price you’ll be paying for gold, it’s worth exploring other investment choices too – as Warren Buffett says, perhaps you might like to own all the farms in the US or ExxonMobil instead?!

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