Mainstream financial advice often likes to downplay the importance of gold to investors. Thankfully, many investors understand how vital gold is to the performance of a well-diversified portfolio. The question then becomes how best to invest in gold to ensure that it is put to work in protecting your assets. Choosing the wrong method could result in impaired performance of your investments.
Gold Mining Stocks Don’t Perform as Well as Gold
Some financial experts believe that investing in the stock of gold mining companies is as good as investing in gold. When gold prices rise, the thinking goes, gold mining stocks will rise too since the price for their product is increasing. What that line of thinking fails to appreciate is that gold mining companies are companies like any other. They have fixed costs, labor expenses, utility expenses, etc. that eat away at their profit margins. Extracting gold takes vast amounts of resources, often requiring dozens of tons of rock to be crushed and processed in order to accumulate just one ounce of gold.
Management of gold mining companies can be poor too, failing to take advantage of every opportunity to mine gold. Gold mining requires exploration, always looking to the next mine before the current one runs out of gold. If the mining company is a small one, they may not have enough mines in operation to bring in enough gold to make it economically worthwhile to invest in the company, or they may not have the ability to attain mining concessions from governments.
Even with record-breaking gold prices, many mining companies may find it hard to break even, as the cost to mine an ounce of gold is over $1000 per ounce. Because gold mining is so resource-intensive and has such high fixed costs, gold mining companies can actually lose money even when gold is hitting record highs. That makes gold mining stocks a poor proxy for gold. Just take a quick look at the CBOE Gold Index, an index that tracks 10 of the most important companies involved in gold mining. While gold was making record gains and outperforming stock markets, the index was actually declining. Gold’s price appreciated nearly 100% between 2008 and 2013, while the gold mining index lost nearly 5%.
Gold mining stocks should not be considered to be anywhere in the same class as gold. At best, they should be treated just like any other company for investment purposes and evaluated for the company’s performance rather than the rising price of their products.
Paper Gold is Not as Good as Real Gold
Another popular method to invest in gold is through exchange-traded funds (ETFs). Gold ETFs claim to purchase physical gold and then issue shares to sell to investors. Each share is a share in the trust that owns the gold but is not actually a share of gold. The share’s price is supposed to track the spot price of gold, but how much physical gold does each share relate to? No one really knows. Does $2,000 worth of shares equal $2,000 of gold held by the trust, or is there only $1,000, or $500, or less gold backing those shares?
Just like banks got into the habit of fractional-reserve banking, loaning out many multiples of the base money held in deposit accounts, what is to keep gold ETFs from creating $10 worth of shares for every $1 of gold they hold? The fact that most gold ETF investors will be either unwilling or unable to demand redemption of their shares for gold makes it incredibly easy for shares of paper gold to far exceed the supply of physical gold.
There’s not really any way for most ETF investors to take physical possession of gold if they decide to liquidate their shares in the fund and take delivery or move gold from one custodian to another. The most popular gold ETF only deals in quantities of 100,000 shares when buying or selling gold, which at the latest share prices is near $12 million. If you’re a small-scale investor with a couple dozen shares or even a larger-scale investor with $1-2 million of shares, you’ll have to arrange things with your broker and hope that you can find an “Authorized Participant” in the trust who will work with you to take possession of physical gold or move it into another investment vehicle.
Physical Gold Is the Best Investment
That’s why investing in physical gold from the beginning is the best way to own gold. For smaller gold investment, you can purchase gold coins that can be socked away in a drawer or in a bank safe deposit box. That imposes some cost, though, and the risk of theft is ever-present. But knowing that that gold is readily available when you need it can provide some comfort.
An easier way to invest in physical gold is through gold IRAs. A gold IRA takes advantage of loopholes in the tax code to allow investors to purchase physical gold with pre-tax dollars and hold them in an IRA account. The gold must be held by an IRS-approved custodian, who is responsible for reporting to the authorities that they hold the amount of gold that they claim. There are no shares issued to obfuscate how much you actually own. When you purchase an ounce, or 10 ounces, or 100 ounces of gold and hold it in a gold IRA, you own that ounce, or 10 ounces, or 100 ounces.
With a gold IRA, you don’t have to worry about the management of a mining company or pore over its SEC filings to make sure that you’re making a financially sound investment. You don’t have to worry about multiple shares being issued for every dollar of gold you hold. You can track the value of your investments just by following the gold price that’s prominently quoted every day in newspapers and financial media.
Gold IRAs allow you to enjoy the tax-free growth of your assets until you decide to or are required to take distributions from your account. Once you take that distribution, you can elect to take it in cash or in gold, giving you the flexibility to fund your retirement with cash or to continue owning gold for future appreciation. That makes it a win-win for investors who want to use gold to protect their retirement assets.