Gold is a relatively rare precious metal and it is extremely durable, so it tends to maintain its value better than other assets such as property or equities. It is therefore an important means of diversifying one’s portfolio and providing a form of insurance against shocks in the market by investing in gold.
We recommend that about 5% to 15% of one’s portfolio should be allocated to gold or gold-linked investments. There are several ways that you can achieve this.
Investing in physical gold should be regarded more as a type of financial insurance than an actual investment. It is purchased in order to hold for the long term, ensuring wealth preservation and even for passing on to future generations, since it will retain its value better than other investments.
Physical gold is a universal finite currency that is retained by most central banks, whereas other investments such as stocks, shares and other investment products are more speculative in nature. These can be considered once you have secured a base in physical gold. Just as you won’t trade an insurance policy, you shouldn’t trade your gold bullion.
Gold Bullion Bars
Bullion bars are available to individuals to purchase, without the past restrictions on the private ownership of precious metals (such as the US ban on the private ownership of gold bullion and coins between 1933 and 1964).
The spot price of gold is the sole determinant of the value of gold bullion bars, and it is not as vulnerable to market fluctuations as with other investment vehicles.
Gold bullion bars are available in two main formats; cast bars and minted bars. Cast bars are produced simply by pouring a fixed amount of molten gold into mould and letting it solidify, after which the bar is removed from the mould or cast. Minted bars are produced by stamping the cast bars with a pressing machine in order to form a standard shape, usually rectangular, but also square or circular. The stamping adds value to the bar.
Gold bars are usually cast or minted in the form of 1oz, 5oz, 10oz or 1kg in weight.
Different regions of the world use slightly different methods and standards to produce gold bullion bars, leading to the availability of a variety of formats. These include the Kilogold bar which is currently the world’s most popular form of bullion bar, the Baht bar which is common in Thailand, the Tael bar which is named for the Chinese unit of measurement, and the Tola bar which is common in countries such as Pakistan.
The EU Gold Directive of 2000 allows buyers in the UK and the EU to purchase investment-grade gold bullion free of stamp duty and VAT-exempt. Similar provisions also apply in several other countries, making physical gold an increasingly attractive form of investment.
Modern Gold Coins
Modern gold coins are investment-grade legal tender that enjoys a slight premium over the spot price of the metal quoted on the markets.
Numerous countries, including the USA, the UK, Canada, China, Australia, South Africa, and Austria mint silver, gold and platinum bullion coins that are available to the general public. Bullion coins are usually minted in 1oz, 1/2oz, 1/4oz and 1/10oz sizes, while some are also available in 2oz, 10oz or 1kg formats, but by far the most popular among HNW individuals are 1oz gold bullion coins such as Britannia’s, Gold Eagles, Gold Pandas and Krugerrands.
The advantages of the owning bullion in the form of legal tender coins, and of the divisibility of holding it in the form of such coins, are well-understood and appreciated.
Numismatic and Semi-Numismatic Gold Coins
Numismatic coins are older coins that, in addition to their precious metal content, also have historical value owing to their rarity and aesthetic appeal. Therefore they sell for a premium above their precious metal content value, with the premium being dependent upon factors which are determined by their age, condition, rarity, and historical significance.
Numismatic coins are leveraged to the gold price, in that their price will tend to increase at a faster rate than the spot gold price during a bull market, but will depreciate faster during a bear market, as numismatists feel the corresponding need to grow or reduce their collections.
British gold sovereigns, which incidentally were originally one pound legal tender coins and are CGT-exempt, are the world’s most popular numismatic gold coin.
Semi-numismatic coins are modern, limited issue, precious metal coins that may have a slight premium owing to their rarity, but whose value is largely determined by the spot gold price. Their value is therefore not as high as that of numismatic coins, but is more tied to that of the underlying commodity.
Examples of paper gold are shares in gold mining and exploration companies, gold futures contracts and accounts, and accounts in gold pools.
Paper gold allows you to expose a portion of your portfolio to the gold market without having to actually own physical gold. As was said earlier, physical gold can be viewed as a long term ‘insurance’-type investment, whereas paper gold can be used for short-term trading and speculation.
Since mining stocks are affected not only by the spot price of the metal, but also by the company’s debt load and infrastructure costs, as well as changing government regulations, they generally reflect the broader trends in the stock market rather than movements in the precious metal markets alone. For this reason it is wise, if investing in gold mining and/or exploration companies, to diversify investment across several companies.
With futures options and gold pools, one is betting on the future price of gold, with the expectation of cashing in when the price rises sufficiently above your purchase price. However, you don’t own any gold, nor do you have the right to take possession of any gold.
All of these products involve a relative degree of ‘leveraging’, meaning that you could increase your investment and win big if the gold price rises sharply, but equally, you could lose out badly if the gold price goes into decline. The risk is magnified by the fact that it is widely believed that there may be over 100 times the value in paper gold being traded than there is physical gold available to back the paper.
Paper gold is considered more suited to institutional funds and traders, while those seeking a secure investment should rather stick with physical gold. So, unless you’re an inveterate gambler, it is wise to only invest in paper gold with funds that you are in a position to do without.
US Gold Certificates were issued from 1863 until 1933 as a form of paper currency, with the 1934 issue being only for use by banks. With the withdrawal of the US from the gold standard in the early 1930’s, these certificates became worthless and most were destroyed. Until 1964 it was illegal to own gold certificates, but since then they have been redeemable for modern currency at face value, and most of the surviving US Gold Certificates are considered collectors’ items.
Presently, the only government-backed precious metals certification programme in the world is the Perth Mint certificate Programme, which allows ownership of investment grade gold stored in the vaults of the Perth Mint in Western Australia. Lloyds of London are the insurers of the gold.
The one drawback with this programme is that the gold held in the Mint’s vaults is ‘unallocated’, meaning that you don’t gain ownership of a particular bar of gold, but simply an undertaking from the Mint that it will give you the amount of gold that you purchased if you ever want to take possession of it, or to sell it.
However, there will not be any applicable shipping, holding, custodial or insurance costs, so it is a very cost-effective and popular method of owning bullion for the long term. In addition, the investor is able to transfer the investment to an ‘allocated’ account (where an identifiable portion of the bullion is allocated to the investor’s legal ownership, with the holder being the custodian) for the payment of a small ‘fabrication fee’.
Allocated accounts differ from unallocated ones in that they relate to ownership by an investor of specific gold bars or coins, which can be shipped or transferred to an individual’s account in a bank or depository.
This is a very safe means of owning gold since each piece of bullion is audited and accounted for. Before selecting an allocated gold account provider, however, it is essential that the investor or their representative undertakes due diligence on the service provider’s credit rating, net worth and security, as well as their service history.
Gold exchange-traded funds (ETFs)
ETF shares offer a means of investing in the gold market on a limited budget, since they are usually based on less than one ounce of gold, generally tracking the price of 1/10oz of the metal.
Most ETF’s, however, don’t permit the redemption and possession of the gold that the investment represents. Investors are therefore exposed to counter-party risk, where the transaction partner may not be able to fulfil their undertakings.
Should you wish to diversify your gold investments to include ETF’s, choose a fund that allows redemption in gold or one whose shares are fully backed by gold.
Bear in mind that ETF’s are best suited for small, short-term trades, and that they usually require an annual administration fee of 0.4% to 0.5%.
Digital Gold Currency (DGC), or ‘gold grams’
Digital gold currency is also known more colloquially as ‘gold grams’ or ‘e-gold’ – not to be confused with the company of the same name which was the world’s first digital currency operator. DGC is a form of digital money which is based on the spot price of gold, and is only traded on-line.
Trading in DGC can be undertaken from anywhere in the world where there is a connection to the internet. This, along with the fact that the value of a DGC can correspond to as little as one gram of gold and that there are no management fees, lead many to view DGC as a relatively cheap means of gaining exposure to gold.
Investments in digital gold currency are considered pooled accounts and they can be exchanged for physical gold from the issuer, either in allocated or unallocated form.
Digital Gold Currencies are considered private currencies since they are not issued by governments. As such they are not subject to banking regulations, and a Global Digital Currency Association was established in 2002 as a nonprofit organization intended to regulate the activity of issuers, but membership is not compulsory, nor does the GDCA have any real powers.
Risks involved in DGC investments include that the issuer may not be properly managed, potentially leading to ‘bankruptcy’ and the loss of investors’ funds. Other risks to clients’ funds include poor data security, hacking and failure of the issuer’s computer system.
Finally, since many issuing firms are not subject to external audits and do not disclose their gold holdings, there is the risk that the issuer does not in fact own any gold, so again, DGC should only be considered for short-term transactions, or diversification of a portfolio that has a sound base in investing in gold.