With geopolitical tensions rising and concerns growing about stagflation, gold is suddenly in the spotlight again. The spot price has surged from just under $1,300 in 2019 to over $2,000 in 2023, and many analysts predict a continuing bull run in the coming years.
While gold doesn’t produce any income or cash flow, it continues to attract many investors as a unique asset that serves as an alternative to traditional stocks and a safe haven against political risks. In this article, we explore the pros and cons of the five main ways in which investors can gain exposure to the precious metal.
1. Gold exchange-traded funds
“The simplest, cheapest and most liquid way to invest is via an ETF, ideally backed with physical Gold rather than just synthetically done with futures,” says Clive Ponsonby, a former JPMorgan forex trader and the author of Currency View, a monthly research series on forex trading.
“These typically come with an expense ratio (annual fees) around 0.5% and bid/offer is usually much less than 1% and sometimes only a few bps. There is a very low probability of fraud or losing your investment.”
Investing in gold through an ETF offers distinct advantages, primarily driven by the ETF’s instant liquidity and low costs. ETFs provide investors with the ability to quickly and easily enter or exit positions, as these investment vehicles are traded on major stock exchanges. Additionally, ETFs typically have lower expense ratios compared with other forms of gold investment, making them cost-efficient options for investors. There is also a very low probability of fraud compared with other forms of holding gold.
The disadvantage is that in the event of a complete government breakdown, investors do not possess the physical gold, and it will be challenging to access or liquidate the ETF if the banking system has collapsed. That said, one can argue that in this eventuality, people will have bigger things to worry about.
2. Gold coins and bars
Another option for investing in gold is through physical gold holdings, such as gold coins like Britannia, American Eagle or Krugerrand. One advantage of owning gold coins is their aesthetic appeal. Moreover, investors have the tangible benefit of physically possessing them, providing a sense of ownership.
“Gold bars are comparable to gold coins, but typically have lower premiums and discounts when buying or selling, as they are easier to verify and often larger in size,” says Ponsonby. They offer similar advantages and disadvantages to those of coins, but with lower costs and less emphasis on collectibility.
It's important to note that holding physical gold involves additional considerations for storage and security, and may incur insurance costs.
3. Gold futures
Investing in gold futures is another way to gain exposure to the precious metal. Gold futures, similar to ETFs, are financial derivatives tied to the underlying commodity. Futures markets allow investors to speculate on the future price of gold without the need to physically own or store the metal. The liquidity of futures markets often makes it easier to enter or exit positions, providing flexibility for traders. Additionally, the leverage available in futures trading can offer opportunities for enhanced returns.
The main disadvantages of investing in gold through futures are the risks associated with financial derivatives, which can include complex pricing mechanisms and potential volatility. This introduces an additional layer of complexity compared with direct ownership of physical gold or investing through more straightforward methods like ETFs.
4. Currency pairs
It might not be obvious to most people, but gold can be traded in the same forex marketplaces as any currency pair. It is commonly represented by the ISO symbol XAU (where 'X' denotes spot and 'AU' represents the chemical symbol for gold). Gold can typically be traded against major currencies. However, it is important to consider the drawbacks, such as potential daily rolls that can erode profits and prove costly compared with futures. On the positive side, trading gold offers the advantage of a narrow bid/ask spread and can be executed through margin accounts.
5. Gold mining stocks
Finally, investing in gold mining stocks is also a popular approach for some investors. These stocks often pay dividends but are not solely dependent on the price of gold; instead, they are closely correlated to it. Some ETFs even offer a basket of such mining stocks. One advantage of this method of investing is that it can be viewed as a leveraged bet on the gold price. For instance, if a mining company's production costs (which tend to be relatively fixed) are around $1,200/oz and the price of gold is $1,500, the profitability per ounce would be $300. However, if the gold price rises by 20% to $1,800, the profit doubles to $600.
The main disadvantage is that there are other factors that can influence the share prices of gold mining stocks: company-specific performance, market sentiment and broader economic conditions. This means investing in gold mining stocks involves additional risks beyond the price of gold itself. By investing in stocks, one is exposed to business and operational risks inherent in the mining industry.
Conclusion
Given the different ways to invest in gold, how should an investor decide? For those primarily focused on trading gold and seeking short-term opportunities, gold futures and currency pairs offer a direct and dynamic approach. On the other hand, if the goal is to hold gold as a medium to long-term investment, ETFs can serve as a suitable investment vehicle.
Ultimately, the choice depends on individual preferences, risk tolerance and investment goals.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.