How to Invest In Gold
Learn which factors influence the price of gold and the various options to invest in gold.
Investing in gold is mostly done to hedge against risk. This is because gold is considered a safe option and in times of economic uncertainty, it is common for its demand to rise among investors.
In fact, out of all precious metals that are able to be invested in, gold is considered the most effective as a hedge and as a safe haven. Before you begin to invest in gold, it is important to understand what drives the price of gold.
Factors That Determine the Gold Price
Central banks determine the gold price in that they hold some of their reserves in gold. Slightly over ten years ago, the amounts of gold held by official organizations and central banks amounted to approximately 19% of all mined gold.
In addition, due to international agreements, central banks in some of the developed world countries are more likely to buy gold than to sell it. Or, even if they sell it, it is in limited amounts.
The Washington Agreement on Gold, for instance, restricts the amount of gold that its members can sell to 500 tonnes per annum or less. The signatories to the Washington Agreement on Gold include the countries with the highest level of gold levels.
The signatories include Japan, Australia, United States, Europe, the International Monetary Fund and the Bank for International Settlements. Thus, when central banks are adding to their gold reserves, that spurs demand and thus applies upward pressure on the price of gold.
Another way that central banks influence the gold price is through interest rates. Gold’s price has a highly correlational relationship with the prevailing interest rate.
When central banks raise interest rates, the price of gold tends to go down since investors move their capital out of gold into interest earning assets such as bonds. Conversely, when interest levels drop, the opportunity cost of holding gold drops as well, thus making investing in gold more attractive.
Industrial and consumer demand
In a breakdown of the global demand for gold, two-thirds of it goes into the jewelry industry. In terms of volumes, the Indian subcontinent leads in consumption. According to 2009 statistics, India accounts for 27 percent of that demand. China follows in second position while the United States is in third position.
Gold demand for dental, industrial or medical use is around 12 percent of total gold demand. Though it is used sparingly due to the cost factor, gold comes in handy in industrial use. This is because it is a very powerful conductor of heat and electricity. It also does not tarnish easily.
Protection of wealth
In times of financial stress, gold finds use as a hedge and insurance. This is because it is viewed and has been proven to possess enduring value. In uncertain times, it’s safe haven status ensures that the demand for it rises thus leading to price increases.
Demand for gold also rises in contrast to a decline in actual or expected returns on investments in stocks, real estate, bonds or other investments.
Demand for gold also rises during times of political instability or uncertainty and it is a hedging tool against inflation, deflation and currency devaluation.
The US dollar
Gold’s price has an inverse relationship to the dollar. When the US dollar is in a strong position relative to other global currencies, the price of gold tends to go down. When the US dollar is in a weaker position relative to other world currencies, the price of gold tends to go up.
This is attributed to the fact that when the US dollar is in a strong position, people tend to trade and invest in US dollars. In times of a weak US dollar and economic crises or uncertainty, people tend to go for safe havens of which gold is a perfect candidate.
Options for Investing in Gold
One of the ways to invest or own gold is through gold coins. The price of a gold bullion coin depends on its fine weight. A small premium may be placed on the final price depending on forces of demand and supply.
Gold coins usually weigh anything between two ounces and one-tenth of an ounce. The most easily available and the most popular size of a gold coin is the one-ounce coin. The gold coin with the widest circulation is the Krugerrand. 1,400 tonnes of Krugerrand coins are in circulation.
Other gold coins that are also commonly available include the Canadian Gold Maple Leaf, the British Sovereign, French Napoleon and the American Gold Eagle.
Gold bars are widely held by central banks and there is also large demand among private investors. most traditional form of investing in the yellow metal.
There are some countries where gold bars can be sold or bought at selected banks. These include Austria, Switzerland, Canada and Liechtenstein. Besides banks, gold bars can also be bought and sold at bullion dealer shops.
Gold bars vary in sizes. In Europe, for instance, a bar could weigh as much as 12 kilograms. There are also bars that weigh one kilogram and are quite popular.
Compared to gold coins, gold bars usually enjoy a lower premium on price. The problem with large bars is that they carry a higher risk of forgery since they are not as easy to judge by appearance as gold coins. It is easier to identify fake gold coins since all you have to do is measure and weigh against the known values. This cannot be replicated with gold bars, though.
Even established and experienced gold dealers insist on re-assaying before a transaction can be completed. But, with larger bars, even assaying doesn’t completely rule out forgery. This is because forgers can create a hollow cavity inside the bar and fill it with tungsten, which assaying will not detect.
ETPs and ETFs
Investing in a Gold Exchange-Traded Products or ETPs is a convenient method of profiting from gold prices or preserving wealth in gold. It not only takes away the inconvenience of having to store the physical bars yourself but it also eliminates the security risk that would be posed by that.
Just like ETPs, Gold Exchange-Traded Funds or ETFs also eliminate the need for an investor to store physical gold bars. The initial Gold ETF originally came into being on the Australian Stock Exchange in 2003. Still in existence to this day, it is known as Gold Bullion Securities and it is the largest gold ETF. Another popular gold ETF is the SPDR Gold Shares.
Another option for those desiring to invest in gold is to buy stocks of gold mining companies. All things being equal, the appreciation of the gold price would be directly proportional to a rise in gold mining stocks.
If the price of gold goes up, it is safe to assume the mining firms would be able to generate higher profits and thereby pushing their stocks high. But, this is the ideal situation and it is important to note that the performance of a gold mining company is dependent not just on the gold price but also on management, efficiency and many other factors.
Strategies to use when investing in gold
There are too many strategies to be considered when venturing into gold trading or investing. You can either use fundamental analysis or technical analysis to plan and execute your gold trades.
Fundamental analysis involves use of economic data such as interest rates, inflation, economic growth rates, energy prices and so on. Technical analysis on the other hand involves use of charts, leading and lagging indicators, pivot points, Fibonacci numbers among others.