New Collector/Stacker help guide How to Invest in Gold

[Bumble]

How to invest in gold: some possibilities.

1. Buy gold yourself and store it. This carries no counterparty risk, but you will need to find somewhere secure to hold it. Using a bank vault is probably not a good idea, because if there is a banking crisis the banks will close and you will not be able to access your vault just when you need it most. It is better to use a private vaulting company or get creative about concealing the gold in your house.

2. Allocated and segregated. Allocated means you buy and store gold through a company, but you are the legal owner of the gold; the company is legally only a bailee, meaning they have possession but no other rights. The significance of allocated ownership is that if the company goes bust, its creditors have no claim over the gold because it is your asset and not the company's. Segregated means that the gold you own is individually identifiable as your property, i.e. it consists of bars or coins with serial numbers or in a container with your name on it, so you can prove exactly what is yours. This is the most secure form of storage, but also the most expensive. Companies like Baird, GoldCore and IMGold offer this kind of service.

3. Allocated and unsegregated: sometimes called pool allocated. You are still the legal owner but your gold and other customers' gold is held in a common pool of indistinguishable assets. If the company goes bust, your assets are protected from the company's creditors, but it may be harder to prove what is yours. This is the kind of service provided by companies like BullionVault and GoldMoney. It is typically cheaper than option 2 and you usually still have the right to take delivery of your gold if you choose.

4. Unallocated but physically backed and with right of delivery. This means that the company takes your money and undertakes to own an amount of gold at least equal to the amount you paid, but the gold is not your property. In effect, you are buying a special kind of bond from the company, but you do not own the gold, and if the company goes bust you are just one of many creditors and may not get all your money back. This does not mean it is a bad option: it depends how trustworthy the company is. The Perth Mint offers a service like this, and because their business is buying, processing and selling precious metals, you may have enough confidence that they own sufficient gold at any given time to cover all their contracts. With Perth Mint, you also have the right to take delivery of gold, though if lots of customers all try to do this at once, you may find yourself at the back of the queue waiting for some doré to be processed. This option is cheaper than 2 or 3.

5. Unallocated, physically backed but with no (or dubious) right of delivery. This covers products like GLD where the fund undertakes to buy gold to cover the units it sells, but you do not own the gold and you may not be able to take delivery. Delivery may be restricted to customers with very large holdings. Even if delivery is stated as an option, the small print may say that the company has the right to settle in cash if they choose, and maybe at yesterday's or last week's fix price. This means if there is a sudden explosion in the gold price caused by a financial crisis, you may get screwed by being forced to accept a cash settlement at the pre-crisis fix price. This option has the virtue of being simple and convenient because you can just buy and sell through your broker.

6. Unallocated, not physically backed but hedged. This covers funds where the company may not own any gold at all, but may use some combination of futures, options or other instruments to hedge the price of gold so they can afford to pay you when you sell. You have no right of delivery. As long as the hedging strategy of the company works, your investment will track the price of gold, but if there is a large move in the price, or if the company experiences its futures and options contracts being defaulted upon by third parties, then they will simply claim force majeure and you will lose out. This option is also easy and convenient and may be cheaper than 5 because there are no storage costs to be covered.

7. Unallocated, not physically backed, unhedged. This is merely an investment in a company with no security. The company claims that your investment will rise and fall in line with the price of gold, but there are no tangible or financial assets to serve as a guarantee of this. As a customer, you are risking your money on the invesment skills of the company.

Other ways to expose yourself to the gold price are:

8. Futures, options, leveraged ETFs, spread betting. These are not for the faint-hearted: they can provide a high level of leverage, but it means you can lose out big time if the price moves against you. Also, in the event of a major crisis, the providers may claim force majeure, so you have no security.

9. Shares in gold mining companies. This can be done either directly or using a fund. Picking miners yourself requires setting aside time to study reports and familiarise yourself with terms such as all-in sustaining costs and reserve replacement ratios. Or you could buy tips from newsletter publishers. The alternative is to invest in an ETF of gold miners such as GDX, SGDM or AUCP, or a managed mutual fund such as Blackrock Gold and General. Miners are typically highly leveraged against the price of gold, especially when prices are low. On the downside you are exposed to all kinds of additional risks such as natural disasters, wars, revolutions, nationalisation of assets, strikes, management incompetence, stock market crashes, etc.  

Which option works best for you will depend on what risks you wish to protect against. Option 1 is the only one with no counterparty risk, though you have to guard against the risk of theft, and there is still the risk of confiscation by governments. With options 2 to 4 you have the risk that the provider may defraud you, but if you consider the companies to be reputable and you trust their auditors, the risks are relatively low. Options 5 to 9 will not protect you in the event of a major crisis.

Usual disclaimer applies: this is not advice or a recommendation; do your own research; seek professional advice; I disclaim responsibility for errors.