How to invest in Gold?
Baffled by gold? This guide will help you to navigate the gold market.
What is gold?
Gold is a yellowy and malleable metal. It is part of the commodity universe.
While gold is a commodity, it is different from most commodities. For centuries, gold is money. Gold is wealth. No other asset has the mystique and ornamental appeal of gold. Wars had started for the want of gold. And gold symbolises prosperity. It is no coincident that historians often called a prosperous period a 'Golden Age'.
Can you trade and invest in gold?
Yes you can. Back in the Great Depression, however, US citizens can't even own gold legally. But that has changed, especially after gold was delinked from the US Dollar in 1971. These days you can acquire gold exposure in many ways, including:
- Physical gold (bars and coins)
- Gold futures
- Gold funds and exchange-traded funds
- Gold miners shares
- Spreadbetting gold prices
- Gold options
What is the attraction of gold?
People invest in gold for a variety of reasons. They believe that gold provides stability. Some believe that gold is a hedge against inflation. Many ardent proponents of gold, called goldbugs, believe that gold is the ultimate hedge against money printing. They often point out that gold is up from $35 in 1971 to $1,500 now - a gain of 4,100%!
During periods of market stress, traders and investors tend to buy gold, however temporarily. They believe that gold prices move inversely to other assets like stocks. Whatever the reason, gold trading has increased significantly since 2000.
What are the major risks of trading gold?
Like all asset classes, gold prices can go up and down.
Gold had a long bear market during 1980-2000. Then, out of the blue, prices bottomed out and surged for the next decade. During this lengthy bull market, prices appreciated every year for ten years. How extraordinary! (see below)
Unsurprisingly after such a strong bull market, prices corrected sharply for the next few years from 2013 onwards. Historically gold prices have fluctuated massively over the years. This may increase portfolio risk when prices correct.
It must be pointed out that when trading gold futures and options, you must be aware of the inherent leverage. Gold prices themselves are already volatile enough. Coupled with leverage, this is a recipe for volatile - and sometimes disastrous - results.
What moves gold prices?
Over the short term, gold price movements are pretty much random. You can spot numerous technical patterns on gold charts but many such patterns fail. A corrective stock market can put cause gold to rebound despite looking toppy; or a 'risk on' phase could pull gold lower.
Over the intermediate term, gold prices trend, be it up or down. Over the long term, gold prices are dependent to supply and demand.
Therefore, if you are a gold investor, you aim to buy gold after a big correction - and sell after a long bull market.
For gold traders, follow gold trends with trend-following indicators like 150-day moving average.
What are the cost of trading and investing in gold?
Depending on what you own, there are cost in investing in gold. Owning physical gold, for example, entails storage charges and insurance cost.
Trading financial gold prices - such as spread betting - will incur transaction costs and slippage.
One word of warning: the cost of trading gold often increases during volatile sessions because brokers will widen spreads. Sometimes, they will increase margins significant because the exchanges demand more collateral.
What are the instruments to gold indirectly?
On pure gold exposure, you may consider the ETF like ETFS Gold (PHGP).
For UK gold miners, you may look at Centamin (CEY), Hochschild Mining (HOC), and Polymetal (POLY). The latter is a £5.6 billion Russian gold miner.
Note that gold miners may sometimes move differently from gold prices. Gold mining shares can drop even when gold prices are rallying simply because of the negative operational outlook and a weak stock market.
Readers should know by now that in times of market distress, investors buy gold. The yellow metal has always been the ultimate safe haven asset.
With the world economic outlook darkening, gold has risen from US$1,200 to US$1,300. Could this be the start of a sustained medium-term rally? If yes, how should one gain exposure to gold?
How To Gain Exposure To The Gold & Other Precious Metals?
1) Physical precious metal bars or coins and store them in bank vaults (with annual charges, of course). There is an active market for these assets in the UK.
2) Precious metal stocks, such as:
- Fresnillo (FRES - large-cap silver)
- Centamin (CEY), Acacia (ACA), Hochschild Mining (HOC), Polymetal (POLY) - midcaps
Do remember that precious metal stocks and precious metal prices may not move exactly. Stocks could vastly outperform or underperform the underlying metal.
3) Exchange Traded Funds (ETFs), such as:
- ETFS Gold (PHGP)
- ETFS Silver (PHAG)
Saxo Capital Markets, for example, offers a wide range of Gold ETFs. Note there will be an annual management fee for these ETFs and some will be US Dollar denominated.
4) Spread bet on gold/silver prices directly with a large number of spread betting firms, such as IG
Note that spread betting gold prices is more speculative because the leverage is higher. Also, these prices are based on futures prices, which need to be rolled over at certain months.
5) Options on gold/silver prices. You pay a premium to buy gold/silver at certain prices. This premium depends on price volatility, interest rates, and the strike price. You could win or loss a large amount of capital with options.
Quick Look At Precious Metal Charts
Over the past five weeks, gold went up from $1,200 to $1,300. In terms of risk reward, gold is not too bad. This means that speculative froth in the gold market is not huge. A stampede to dump gold is unlikely because there is no huge leveraged positions (yet).
But, did you know that within the precious metal sector, the clear leader is not gold but Palladium? This metal is soaring because of high expected demand. It achieved parity with gold price late last year and has been racing higher ever since. It is now $40 more expensive than gold! Clearly, Palladium is near-term bullish but vulnerable to more volatile corrections due to its accelerative trend (see below).
The most under-owned precious metal is probably Silver. This instrument had a huge speculative bubble back in 2011 but has dropped off investors radar screen. It touched a low of $14 last year. Silver's recent rally could be the start of a new medium-term rally - although be aware of $16-18 resistance range which might impede its advance for some time.