Gold may not be used as a currency in the same way it was decades ago, but this precious metal can still be an important part of your portfolio. Gold offers a hedge against inflation in paper currency and it can help diversify a portfolio that’s heavily weighted towards stocks.
In this guide, we’ll not only explain why gold has value for investors, but we will also explore the best way to invest in gold so you can be successful!
Why Invest in Gold?
The main reason to invest in gold is to diversify your investment portfolio. Gold has a few qualities that make it ideal for diversification.
First, the value of gold increases during periods of economic uncertainty. It’s not affected by inflation or deflation in paper currencies like the US dollar. Rather, when inflation happens, the price of gold simply increases along with everything else (and often more so, since investors flock to gold when inflation rises). When deflation occurs, gold holds its value and thus offers increased purchasing power relative to cash.
Another key reason to diversify with gold is that changes in its price are negatively correlated with ups and downs in the stock market. When stocks fall, the price of gold tends to rise. So, by investing in gold, you’ll hedge your portfolio against a downturn in the stock market.
Gold vs. Stocks vs. Bonds
For investors looking to diversify away from stocks, gold isn’t the only option. The price of bonds is also negatively correlated with the price of stocks, so bonds often serve as a hedge against stock market downturns.
However, there’s more to this than meets the eye. For one thing, bonds haven’t always been negatively correlated with stocks – depending on economic conditions, it’s possible for stocks and bonds to move in the same direction. Gold, on the other hand, is almost always negatively correlated with the stock market.
Another thing to consider when choosing between gold and bonds is your likely return on investment. Demand for gold is increasing in emerging markets like India and China, which could drive up the value of gold. New gold mines are slow to open, too, so the gold supply can take 5-10 years to catch up to changes in demand.
Your investment return from bonds, on the other hand, is primarily dependent on changes in interest rates. These are set by central banks and will vary in response to economic conditions.
Ways to Invest in Gold
There are several different ways to invest in gold. Let’s take a look at some of the most popular options.
1. Physical Gold
The first way is to simply purchase real gold in the form of bullion or coins. Gold bullion and coins have a defined purity and value that’s based on their weight. Since these assets represent a direct investment in gold, they carry a 1:1 exposure to changes in the price of gold.
Buying physical gold can be problematic, however, since you’ll need to store the gold safely. If you have large holdings of physical gold, you may need to invest in security or insurance, which eats into your portfolio. In addition, physical gold is relatively illiquid – you must buy or sell in increments of coins or bars, which can be worth thousands of dollars and can’t be broken up.
2. Gold Futures and Options
Another option for investing in gold is through the futures and options markets. Gold futures contracts are agreements to buy or sell gold on a future date at a predetermined price. Gold options contracts give you the option to buy or sell gold on a future date at a predetermined price, but you’re not obligated to exercise the option.
The value of gold futures and options contracts is related to investors’ outlook on the price of gold around the expiration date of the contract. The value of these contracts also depends on how close they are to their expiration date. All gold futures and options contracts involve leverage, so changes in the price of gold will be amplified in your portfolio.
3. Gold Stocks
You can also invest in gold through individual stocks. Shares of gold mining companies, for example, typically rise or fall with the price of gold. A key advantage of investing in gold through stocks is that stocks are relatively accessible for most investors. However, gold stocks can suffer during a stock market downturn and they can also be affected by company-specific factors, like a change in management.
4. Gold ETFs and Mutual Funds
Gold ETFs and mutual funds are among the most popular options for investing in gold. These funds can invest in gold mining company shares, gold futures contracts, physical gold, or a mix of all these different asset classes. Be sure to look closely at what assets a fund is invested in, since some funds will be more exposed to changes in the price of gold or more highly leveraged than others.
Types of Gold Stocks
If you want to invest in gold through the stock market, there are several different types of gold stocks to consider. First, there are large-cap gold stocks like Barrick Gold (GOLD), Franco-Nevada Corp. (FNV), and Wheaton Precious Metals Corp. (WPM). These companies all have multiple proven mines and often do everything from mining to refining.
In addition to large-cap gold companies, there are hundreds of small-cap gold companies and gold penny stocks. These stocks include miners, refiners, and exploration outfits, and they may or may not have proven reserves.
You can also invest in gold stocks through ETFs. There are several funds, such as the Van Eck Gold Miners ETF (GDX), that invest solely in gold stocks and not in other gold-related assets. These ETFs give you exposure to a wider range of gold stocks and offer diversification relative to investing in individual gold mining companies.
Conclusion: Investing in Gold
Investing in gold offers protection from inflation and a hedge against drops in the stock market. You can buy gold directly, but many investors choose to gain exposure to gold through futures contracts, stocks, or ETFs. If you want to invest in gold stocks, think carefully about what the company you’re investing in does and whether it has proven gold reserves. Alternatively, invest in a gold ETF to get exposure to a broader swath of the gold mining and refining industries.