Investing in gold is one way to protect your portfolio against economic recessions. Many do not have gold in their portfolios because they are afraid of the risks or don’t know how to invest in gold. There are several ways investors can add gold to their stock and bond portfolios.
Why Invest in Gold
Unlike other forms of currency, gold has held its value fairly well for centuries. Gold has value beyond its use as currency. Much of the gold mined today is used in jewelry as well as electronics, industry, and aerospace.
Gold can be a useful way to hedge a stock portfolio against stock market declines. Gold tends to be countercyclical — when the stock market is falling, gold can often move upwards. For example, as the COVID-19 pandemic spread, gold outperformed most major commodities.
The best way to diversify a portfolio is to spread your risk in a variety of investments that are not closely related to each other. Stocks and bonds are one way to diversify a portfolio. Adding gold will further diversify a portfolio, protecting against stock and bond market downturns.
Gold as a Hedge
Gold can also hedge against a falling dollar. There have been some notable times in history when the dollar fell against other currencies. A recent example occurred starting around 1998 when the dollar fell due to large trade deficits among other reasons. When the dollar falls, gold usually rises as traders sell their dollars and buy gold.
Geopolitical concerns also cause gold to rise in price. When tensions rise around the world, many will start to buy gold. World tensions can increase for reasons like war, pandemics, economic problems, and a loss of confidence in the government. In times like these, gold is considered a safe haven compared to other forms of investments.
Investing in gold can also protect against inflation. As inflation increases, the purchasing power of currency drops. History has shown us that gold usually increases in value as the purchasing power drops. During periods of high inflation, stocks can drop in price, which is another reason some use gold to hedge their portfolios. But do note, that not everyone views gold as a hedge against inflation.
Inflation is one concern, but deflation is another. Last seen globally during the Great Depression of the 1930s, deflation is much rarer than inflation. Deflation happens when the price of items drops in price. That might sound like a positive thing, but it isn’t for the vast majority of people who are not sitting on a large amount of cash. Deflation can occur when business activity slows and the economy is under pressure by excessive debt.
Increased demand for gold will cause it to rise in price. During economic upturns, the need for gold can increase for industrial uses. Demand also increases when emerging countries have an increasing middle class. As their wealth increases, their demand for gold jewelry as well as electronics increases. During times of economic uncertainty, investors rushing to buy gold will also increase the demand.
A decrease in the gold supply could push gold prices higher. But the supply of gold is not expected to run out any time soon. Barrick Gold's Nevada Gold Mines, the single largest gold mining complex in the world, produces 3.5 million ounces of gold per year. Problems at mines like worker strikes and accidents can cause production to fall.
How to Invest in Gold
There are numerous ways investors can gain exposure in gold, each with its advantages and disadvantages. And an investor does not have to stick to just one way to invest, by using several ways, risk can be lessened. The ways to begin investing in gold include:
- Buy gold bars and gold coins
- Buy gold exchange-traded-funds (ETFs), closed-end funds (CEFs) or mutual funds.
- Buy stocks in gold mining companies
- Buy gold certificates.
Gold bullion is normally purchased in the form of bars or coins. This is as easy as going to a precious metals dealer in person or buying it online. Investors can buy gold bars in sizes ranging from a quarter-ounce wafer to a 400-ounce bar.
Buying gold coins is the most common way for beginning investors to own gold. Gold bullion coins purchased for investment purposes should not be confused with collectible coins which have a numismatic value.
Unless you are a coin collector, avoid collectible coins. Their values are based not only on the gold content, but also on the age, rarity, and condition of the coin. Avoid proof coins as well because they will cost more.
The most popular gold bullion coins for gold investors include:
- The American Eagle
- The South African Krugerrand
- The Canadian Maple Leaf.
Always buy gold coins from reputable dealers. Avoid special commemorative gold coins that investors might see advertised. Stick with the popular gold coins minted by governments like American Eagles.
When buying gold coins, investors will always pay more than the spot price of gold. Dealers have to make a profit, and this profit is called the markup. Before buying gold, check the “spot price.” The markup (or “premium”) will be anywhere from 5% to 9% of the spot price (per ounce). Investors shouldn’t pay more than that when they buy gold coins. But be aware that shortages can drive the premium higher.
There are numerous advantages to owning gold coins. A person can hold $50,000 in their hands. Gold coins cannot be destroyed by water or the passage of time.
Other advantages to owning gold coins include:
- Gold coins have high liquidity. Unlike other types of collectibles, gold can be sold almost anywhere in the world.
- Gold holds a lot of value per ounce. They can be stored in a small safe at home or in a bank’s safe deposit box
- It is free of what is called counterparty risk. This means it doesn’t require the backing of a country or central bank.
- Gold cannot be hacked like digital currencies that are held on cryptocurrency blockchains.
- Owning gold is private and confidential.
There are a couple of disadvantages to owning gold coins.
- Storing too much gold at home puts you at risk of theft.
- Gold doesn’t produce income as dividend-paying stocks do. But then again, many of today’s hottest stocks also don’t produce an income in the form of dividends.
- Another disadvantage is that gold can have a higher capital gains tax than other investments.
Shares in Gold Funds
Exchange-traded-funds (ETFs) are bought and sold like stocks. Gold ETFs track the movement of the price of gold. But depending on the particular ETF you invest it, it may or may not be backed fully by gold bullion.
One of the largest gold exchange-traded funds is GLD. Its shares are traded on the New York Stock Exchange with other stocks and ETFs. Each share of GLD represents slightly less than one-tenth of an ounce of gold. If the price of gold is $1,000, one share of GLD will cost around $100. This gives investors an easy and less expensive way to invest in gold and profit from the increase in gold prices.
Be aware that for many gold-backed ETFs, when you buy shares you do not own the actual underlying gold represented by the shares, but you may be taxed as though you do. In the United States, for example, physical gold is usually taxed under the “collectibles” rate, which runs at a maximum of 28%.
For US citizens, an exception is the Canada-based Sprott Physical Gold Trust (NYSE:PHYS) which is backed 100% by gold but is a foreign “CEF” — or “closed-end fund.” This means that the same capital gains tax rates that apply to stock, would apply to your ownership of gold through Sprott. This makes it probably the most cost-effective way to buy and own gold in the United States.
Gold Mining and Exploration Stocks
Those new to gold investing will hear about gold mining stocks. These stocks are another way to invest in gold without actually owning the metal itself. Most of the mines not only produce gold but other precious metals like silver.
Gold mining stocks are far riskier to invest in though. It requires more knowledge on your part. Employee strikes, mining accidents, not finding as much gold as they thought, or finding a new vein of gold can affect the stock price of gold mining stocks.
Gold certificates are a way for investors to own gold without having it in their possession. The most trusted gold certificate is offered by the Perth Mint in Australia.
The government of Western Australia guarantee will cover all of the gold held in storage for holders of their gold certificates.
Taxes on Gold
As we mentioned, gold and all precious metals are usually considered “collectibles” by the US Internal Revenue Service. They are taxed as collectibles when you sell your gold at a profit. This carries a maximum rate of 28%.
The exception is if a US citizen invests in a foreign closed-end fund (CEF), namely the Sprott physical metal trusts, which are taxed at the lower capital gains rate applied to stocks.
All beginners to gold investing should understand capital gains taxes on precious metals and speak to a tax professional before investing.
Wrapping It Up
- Buying gold coins and small bars is the costliest way to invest in gold because each piece carries a retail markup called a “premium.” Also: these items are taxed as “collectibles” at a high rate.
- If you are a US citizen, the Sprott Physical Gold Trust (NYSE: PHYS) is perhaps the most cost-effective way to buy gold, because of its favorable tax status. Shares are quite affordable at little over $14 per share. At this price anyone can afford to invest in gold. Plus you will own the underlying metal that the shares represent.
- There are many ETFs available to invest in. Be sure to understand though how you will be taxed for them and whether or not you will own the underlying gold. You may not care about the latter, but it doesn’t make sense to invest in a gold ETF that is taxed at a higher rate than the Sprott Physical Gold Trust (NYSE: PHYS).
- Mining and exploration stocks are riskier than investing in the metal itself.
- Online services like BullionVault.com provide an easy and cost-effective way to buy gold and they’ll store it for you. But you’ll be taxed at the higher “collectibles” rate if you are a US citizen.
There are many ways to invest in gold, but taking a bit of time to learn the basics will help you avoid overpaying for it.
And that will make you wiser than many people in the market.