Why invest in gold?

There are many reasons why you can consider gold as an investment. Before we go through them, think about the fact that Central Banks all over the world maintain a certain level of reserve in this precious metal. They do it as a means to protect their currency purchasing power.

Some of the reasons why investors like to buy gold are that it can offer certain protection in times of inflation, deflation, economic crisis or movements in currency value. The value of gold increases along with the rate of inflation and during economic or political uncertainty, people resort towards gold.

Let's explain this through an example surrounding the coronavirus outbreak. The supermarkets in some major cities in China have been emptied. This is because people want to stockpile food and other items to overcome the outbreak. However, people don't aim to keep enormous quantities of perishable goods, such as tomatoes, stored in their basements because they will not be edible in several days. Instead, they stockpile goods such as canned food, which last longer and taste good even after a few months.

The idea behind the desire to hold gold in times of economic downturn is similar. People tend to get rid of their local currency because it is losing value and buy gold whose value is increasing. Moreover, it should be noted that gold is inversely related with the US dollar, meaning that when the US dollar value decreases, the price of gold increases (as was evident during the last financial crisis).

Aside from the reasons above, holding gold helps you maintain a well-diversified portfolio composed of different types of assets which move differently from one another. For instance, while during crises the value of stocks may decline, at the same time, the value of gold value will increase, offering you a certain level of protection. Considering the economic occurrences and political conflicts in the past two decades (the 2007 financial crisis, the Eurozone debt crisis, war conflicts, etc) the gold performance is presented in the following graph.

Even though there have been some major negative economic turbulences since 2000, the value of gold is constantly increasing. You can see how much the gold price has increased in 20 years by comparing its price in 2000 to its current price.

If we compare the gold price with the S&P 500 index from 2007 to 2009, we may notice that while the index value has decreased by more than 30 per cent, the gold price has increased by more than 20 per cent.

Aside from the economic factors which impact the value of gold, supply and demand also affect the price. As the world gold supply gets smaller with the number of gold mines decreasing, there is an expectation that gold price may increase in the future.

How to invest in gold?

The question "How do I start investing in gold?" often pops up as the popularity and the price of the asset increases. Here are some of the common gold investment options.

Primary steps investors should take before investing in gold

• Decide how much money you will invest.

As gold can be a volatile commodity, it is recommended that it represents up to 20 per cent of your overall portfolio. Investors with smaller portfolios or smaller budgets should invest up to 10 per cent of their money in gold.

• Decide how to invest in gold.

Will you buy physical gold, invest in gold ETFs, in gold mutual funds, gold mining stocks or go for another investment option.

Steps to buy physical gold

• Choose whether you will purchase gold jewellery, gold bars, gold coins or some other form of gold .

You may pay a higher price for jewellery. Gold coins are a practical way to invest in gold because you can sell off separate coins to get cash if needed. On the other hand, gold bars may be acceptable if you want to invest more money, but they are somewhat illiquid since it is difficult to sell a piece of the bar.

• Find a credible and reputable gold dealer – you can check the central bank website or another relevant authority to see a list of licensed gold dealers or sellers.

This step is highly important because there have been numerous scams associated with buying physical gold.

• Gold vending machines.

Bear in mind that residents in some European countries such as Germany, Austria, Italy, Switzerland and the UK, can buy gold bars (from 1 gram up to 250 grams) from a vending machine.

• Compare gold price between dealers.

Since sellers of physical gold incur certain costs in their business activities and they include the costs in the selling price, there could be a difference in the gold price. Don't forget that you aim to buy the gold at the lowest possible price because a small upward price change could put you in the profitability zone. You would ideally look for a price which is as close as possible to the gold spot price (market price). Try to buy gold with a maximum price of 5 per cent above the spot price.

• Store your gold – after you have purchased it, you should ensure that gold is stored securely.

You can store it in a safe at your home or office or rent a safe at your bank.

Steps to invest in gold exchange-traded funds (ETFs)

Another option for investors to benefit from fluctuations in gold price is to invest in gold exchange traded funds (ETFs). Since ETFs are traded in a similar manner as stocks, the process to invest in gold ETFs consists of the following steps:

• Select a gold ETF – set up a basic criterion for selecting the gold ETF you want to buy in terms of the ETF size, liquidity, etc.
• Decide on your investment budget.
• Define your investing strategy.
• Select your broker and open an account – you should open an account with a broker who allows you to invest in gold ETFs. When selecting the right broker, make sure that you know the broker's fees and charges, minimum deposit requirements, etc.
• Fund your account – there are many ways through which you can deposit money on your account, go through the available options and select the one that suits you most.
• Purchase the gold ETF.
• Monitor the performance of the ETF – after investing in gold ETFs, you should monitor the gold value and the ETFs value to be familiar with the changes in the value of your portfolio.
• Decide when to liquidate your investment – in this step, you decide when you are going to sell your gold ETF holdings.

Gold mutual funds

Gold mutual funds primarily invest in gold bullion or stocks from gold-producing or mining companies. Steps involved in buying mutual funds units are:

• Decide on your investment budget.
• Check for available mutual funds – you should analyse the mutual funds which invest in gold or gold-related instruments by looking at a couple of factors. You can see who is managing the fund, how the fund performed in the past couple of years, compare the fund performance with other similar funds and its investment strategy. Don't forget to consider the fees, you don't want to see your profit being eaten by the fund's charges.
• Invest in the mutual fund – you will purchase units from the selected mutual fund.
• Monitor fund performance.

Gold mining stocks

Another way to invest in gold is to buy shares from gold mining companies. The steps involved are similar to the steps when investing in ETFs. Consequently, you can buy gold mining stocks as follows:

• Define the amount of money you want to invest.
• Analyse potential gold mining companies – you should do the analysis for stocks which you consider as a potential investment. You can do by yourself, or go to a professional investment adviser.
• Open brokerage account – as it was mentioned before, try to choose a broker who has the lowest fees, low minimum balance, easy funding and withdrawal process, etc.
• Develop an investment strategy – your strategy will depend on whether you want to invest in gold stocks actively or you will go with passive portfolio management.
• Start investing – buy stocks and continue in accordance with your strategy.
• Monitor your investments.

Trading gold futures contracts

Futures contracts are a derivative financial instrument whose value is derived from a specific underlying asset. When trading futures, the buyer and the seller enter an obligatory contract for delivery and purchase of the reference commodity. Trading gold futures contracts can be done through these steps:

• Get acquainted with the futures contracts – you should understand at least the basic notion behind the futures contracts before you consider them as an investment.
• Trading method – traders can choose to trade the futures by themselves through their broker's account or they could decide to go with a managed account where a professional trading adviser is executing trades.
• Set up your investment strategy.
• Select your broker – if you decide to trade futures contracts by yourself, the next step is to choose an adequate licensed broker wisely. Again, you should pay attention to the associated fees as well as minimum account balance required by the broker.
• Start trading futures contracts.

As you can see, there is a variety of gold investment options available for investors to make money from changes in the value of the gold. No matter which method you choose for investing or trading in the precious metal, you should always keep on mind the risks involved. Keep in mind that the best way to invest in gold depends on your preferences, expectations and plans.

FURTHER READING: Gold price predictions for 2020 and beyond

FURTHER READING: Is gold a good investment? Five ways to buy it – the pros and cons