(*Hums the Jaws theme.* Da-dum… Da-dum… Da-dum, da-dum, da-dum, da-dum, da-dum, DA! Welcome my friends, to yet another installment of Investing 101. We’re going to get a little bit off the beaten path with this post, looking into investments in gold. There are times, particularly when the future seems to be rather uncertain, that investments in gold start to become popular; if that doesn’t describe our current situation, I don’t know what would.)
Q: What is gold?
A: You’re kidding me, right?
Q: No, you want to write about gold, you have to expect questions like this. So, what is gold?
A: (Sighs) Alright; gold is a chemical element, the 79th on the period table. The abbreviation is Au, short for aurum, the Latin word for gold. Pure gold tends to be soft, allowing it to be easily shaped or molded. Furthermore, it is also very nonreactive; gold is one of the few (metallic) elements that is found naturally in its elemental form. It is also a unique metal in having a yellow, rather than a silver, color in its elemental form. Commercially, gold can be used for electronics, in jewelry, or in dentistry. Most important to our purposes, gold has a history of being used as money, and more recently, as a hedge against paper currencies. (All this information, as well as more about the chemistry of gold than you ever need to know, can be found on the WebElements page for gold.)
Q: Alright, why is gold so valuable?
A: Gold has a fairly unique combination of nonreactivity, beauty, ease of shaping, and perhaps most importantly, rarity. Being almost completely nonreactive means that it is fairly easy to find gold in its elemental form, the beauty of which has appealed to humankind throughout recorded history. Because gold is malleable and easily shaped, it makes a good base for currencies, especially in older periods when metal shaping tools were less advanced.
Its rarity is the real key to gold’s value, however. Because it has been rare in most of the world for so much of history, it makes a good store of wealth. If you were deciding on what to use as currency, you’d want something that was unlikely to vary in quantity from year to year (like most crops) or have a sudden discovery drastically shift the relative value of your currency (as with more common metals like iron). Gold meets these criteria, as well as the previously mentioned traits, and so makes a good potential currency.
Q: How should I invest in gold? Should I just buy up a bunch of gold and put it into my safe deposit box?
A: Well, buying and holding physical gold is one investment option; unlike other commodities like oil or corn, it’s possible to get an amount of gold with a high value in a small enough space to keep in your home (or a safe deposit box). That said, I’d advise against holding sizable (investment) amounts of gold yourself; as with any physical object, there are some issues to consider. You need a place to put your gold (which could take up a large amount of space, if you buy gold bars or something similar), you need to protect your gold against theft or being lost, and you need some way of determining whether the gold you are purchasing is the same quality as you have been led to believe. For all these reasons, it’s worth considering some alternative methods of investing in gold.
Q: Oh? What sort of alternatives?
A: That depends on how directly you want to invest; some possibilities include:
- Gold Certificates: Purchased from a company that holds gold in its own vaults, these certificates provide you a way to ‘hold’ gold in your portfolio without having to physically take possession of the gold. As long as the company is reputable (the Perth Mint in Australia comes highly recommended), it can be good way to own gold and not store it (although, you do have the option to take delivery of the gold at any time).
- Gold ETFs: There are some ETFs in existence that own a sizable amount of gold rather than stocks, bonds, or other financial instruments. By buying shares of such an ETF (which are usually designed to match the current price of gold), you can own gold directly without needing to physical hold it, just as with gold certificates.
- Gold Futures: As with most other commodities, you can invest in gold through the futures market. You can buy a contract to purchase an amount of gold for a certain price at some point in the future, and either take delivery or sell the contract, hopefully for a profit. The same warnings and cavaets apply to gold futures as would with any futures investment; be careful, or you could end up being forced to buy gold you had no intention of purchasing at unfavorable prices.
- Gold Company Stock: A somewhat indirect method of investing in gold, you can hold stock in companies that make a profit by mining gold. If the price of gold goes up, they make more money and you can benefit from their rising value. As with all stocks, though, you have to worry that the price will decrease on bad news, or that the company could even go bankrupt.
Q: Wow, sounds like a lot of options! How much of my money should I invest in gold?
A: As a general rule, not too much. If you are just looking to diverse your portfolio a bit beyond the typical stock and bond mutual funds and possibly hedge a bit against a down turn, holding about 5-10% of your money in these various gold investments can help to diversify you. Beyond that, you could end up putting too much of your money into gold, and if gold prices start to drop, your portfolio would drop with it. Remember to keep your portfolio diversified to be in a good position to benefit no matter which asset classes do the best; in this case, that means having only a small dollop of gold-centered investments in your portfolio.
That’s all for investing in gold; join us next week for another exciting edition of Investing 101!
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The Dividend Guy
on July 23 2009
Hi Roger,
At what point do you think someone should add commodities, like gold, to their portfolios.
My feeling is that they should have their core portfolio built up (i.e. equities, fixed income) before diversifying into commodities.
Roger
on July 24 2009
@The Dividend Guy,
Good point. As I implied, but did not explicitly say in my last set of questions and answers, gold and other commodities should be used primarily as diversifiers in a portfolio that already contains stocks, bonds, mutual funds, and other ‘core’ investments. Assuming you have adequate funds invested in those types of investment vehicles, that would be the time to start considering other, more speculative investments for the purpose of diversification. In short, I’m in complete agreement with you on that point.