Gold investment comes in many forms — and not just your sovereign coins, ingots, shekels, and nuggets.
Different investment vehicles like stocks, ETFs, and bullion bars, offer various ways to get exposure to the price of gold. Each has its own risk/reward profile, and its own set of pros and cons.
🗠 Gold Stocks
“[It] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” — Warren Buffet on why he prefers equities to gold
Humanity’s love of gold has birthed a whole industry — dedicated to mining, processing, and funding the extraction of the precious metal.
This means instead of buying the metal directly, you can get exposure to the price movements of gold through stocks,and also directly benefit from the growth of the underlying company.
Gold equities can be put in two broad categories: mining companies — which dig that gold bullion out of the ground, and streaming and royalty companies — which fund miners in return for the right to a percentage of the proceeds.
Mining stocks can be put into two categories — Seniors, which are less risky, more established companies, and Juniors, which are small cap new companies that tend to be searching for new deposits of gold.
In good times, gold mining stocks tend to outperform the commodity. Not only does the price of the stock benefit from the increased price of gold, but it also benefits from business expansion.
But in bad times, mining stocks can suffer much more than the commodity itself. Not only can the price of the metal plummet, but business operations can go wrong.
Gold mining is a very complex operation, and can be blighted) by the collapse of mines, gas leaks, worker strikes, and any other catastrophes. These can push the stock down, and dividends can get cut.
Due to these business factors, the price of mining stocks is often more volatile than gold.
Streaming and royalty companies can also outperform gold, but are generally less volatile than mining companies.
When gold skyrockets, streaming stocks don’t tend to react as strongly as mining stocks.
But, the same is true when the price of gold plummets, and streaming stocks tend to stay more buoyant.
Verdict: Investors that want to play Warren Buffet and research their own gold stocks always have the possibility of outperforming gold, but there is also more potential for downside, and equities investors enjoy none of the benefits of holding physical gold.
🏦 Gold ETFs
“Think of ETFs as the market’s version of a wolf pack picking off and weeding out the slower and weaker active fund managers in the herd, those with consistently poor returns and high fees.” – Vito J. Racanelli, Barron’s
Investors wanting to get exposure to gold equities without the trouble of stock picking can just buy an ETF, which track the performance of gold indices like the NYSE Arca Gold BUGS Index or the Philadelphia Gold and Silver Index.
ETFs represent easy diversification — giving investors a way to gain exposure to the whole gold mining industry in one single investment that might contain streaming companies, mining companies, and gold itself.
If a single company you have invested in goes bust, then you have enough padding from other companies in the ETF to not be affected.
But this simple diversification comes with downsides.
As you don’t actually own bullion, and can’t take delivery of any physical gold, you can only lay claim to contracts, meaning you are subject to significant counterparty risk, and must rely on a company to make sure your investment is properly managed and secured.
Though you have an opportunity to gain exposure to the price movements of gold, you don’t own it. When things go wrong, this house of cards can fall down. Like in 2016, when the ETF iShares Gold Trust failed to register shares that it had sold with the Securities and Exchange Commission (SEC), which could have meant that the price of the ETF wouldn’t accurately reflect the value of gold.
Though this worst case scenario is unlikely, the fees involved in ETFs will grind down your investment stack over time, and unlike the storage fees paid with bullion, you still don’t have true ownership of the asset.
Gold Vs Gold Bugs ETF
Verdict: ETFs are often seen as a convenient way of gaining exposure to gold, but the counterparty risk involved diminishes its ability to act as a safe haven.
“Gold is money. Everything else is credit.” – J. P. Morgan
Gold bullion gets a bad rep, and is often associated with high commissions, and risks relating to transportation and storage. But done right, physical gold offers a value that surpasses all other investments, as it has virtually no counterparty risk.
Unlike stocks, fiat currency, or ETFS, that are ultimately just pieces of paper saying that you are entitled to something, gold has real value — without the support of a paper contract.
So when the big financial bubble bursts, gold should still be standing, as it has for the past 3000 years.
Even if the rest of the financial system falls apart, those holding physical gold will theoretically still be sitting pretty.
And, bullion bars and gold coins are also very liquid, meaning they can be sold anywhere — from local dealers, pawn shops, or online for quick cash.