Advocates of gold investing believe that it is the best hedge against inflation and stock market declines. Of all the precious metals, gold has consistently been the most popular investment as a store of value. Historically, gold has performed well during periods of high inflation. It must be noted, however, that as with any other investment, money can be made or lost in gold. For instance, both inflation and the price of gold declined in the first 4 years of the twenty-first century. When the price of gold rises above its original purchase price, investors realize capital gains when selling. Capital losses are incurred when the selling price is lower than the purchase price. Net long-term capital gains (gains on investments held for more than 1 year) are generally taxed at a rate of 15 percent, but note that, in certain cases, such as coins, gold is classified as a collectible by the Internal Revenue Service. Long-term capital gains on collectibles are taxed at the 28 percent rate. Because gold investors receive no interest or dividend payments, positive investment returns are dependent upon rising market prices.

Investors can take ownership of their gold in many different forms, such as gold bullion, gold coins, gold mining stocks, gold mutual funds, gold options and gold futures. Gold bullion, or bars, are typically bought and sold through brokerage firms or gold dealers. Gold bars trade at a premium to the market price of gold (i.e., at an amount above this market price). After purchase, the bullion generally remains in the custody of the brokerage firm or dealer, where storage and insurance fees are charged. If, however, the investor decides to take physical possession of the gold bars to avoid these additional costs, a number of other factors must be considered. For example, the gold bars must be stored in a safe place. In addition, when the bars are purchased, the broker or dealer should issue a numbered certificate that matches the numbers on the bars. When the investor sells the gold bars, the certificate must also be presented along with the bars to ensure their identity and authenticity. This does not, however, always prevent the investor from having to assay the gold (in other words, to analyze it to determine its composition) to guarantee its quality. This cost must also be borne by the seller.

Fortunately, storage and assay costs can be avoided by investing in gold coins instead of gold bullion. Although gold coins also trade at a premium to the market price of gold, this form is considerably more cost-effective for small investors. Two important considerations of investing in gold coins are their numismatic value and the gold content of the coins. The numismatic value of the coins is related to their value as collectors' items. For example, South Africa's Krugerrand is a widely traded gold coin; conversely, older and rarer coins such as the French Napoleon typically trade at many times their gold content, which is the second consideration. For instance, the Canadian Maple Leaf consists of 1 troy ounce of fine gold, making it a more attractive investment than a gold coin containing less than 1 troy ounce.

Indirect gold investments can be made through the purchase of the stock offerings of gold mining companies. It should be noted that the prices of gold mining stocks do not always move in the same direction as the market price of gold. This is due to a number of factors. For example, the costs to mine gold can vary significantly among mining companies. The length of a particular mine's life gives one indication of the costs to extract the gold from that mine: a long life implies that the mining company generally won't have to go any deeper into the mineshaft to extract gold, whereas a short mine life implies a deeper, more costly process to remove it. The largest gold mining companies are in South Africa, Canada and the United States.

Gold mining stock prices tend to be more volatile than the actual price movements of gold, which can explain why some gold mining company stocks decline when gold prices rise and vice versa. One reason for this tendency is that some gold mining companies hedge their future output using gold futures contracts. However, despite the overall short-term volatility, gold stock prices generally do manage to keep pace with the longer-term price trends of gold bullion. When investing in stocks of gold mining companies, the wise investor should look for organizations with long lives and low extraction costs.

Gold investors who would prefer not to pay the high costs of storage and insurance or to deliberate the strengths and weaknesses of different mining companies can invest in gold through gold mutual funds and gold exchange-traded funds (ETFs). Gold mutual funds offer a diversified portfolio of gold mining stocks. Savvy investors should seek funds that have low expense ratios, which is one of the major factors to look for when choosing any mutual fund. Gold ETFs offer a convenient way to own gold bullion without having to be concerned with the added costs of storage and insurance. Shares of ETFs are traded on the major stock exchanges.

Gold options can be used either to insure existing investments in gold or to speculate on future changes in gold prices. If an investor expects the market price of gold to rise, he or she would purchase call (buy) options on gold; conversely, put (sell) options would be purchased if the price were speculated to fall.

Gold futures contracts also allow investors to speculate or hedge their positions on gold. These contracts can offer the investor a substantial amount of leverage. For example, if the market price of gold is $500 per ounce and the investor purchases a gold futures contract (which consists of 100 troy ounces), the full value of the contract would be $50,000. If the margin requirement for such a contract is $5,000, the investor actually controls the $50,000 contract value with a fairly small investment. If the price of gold were to increase by $1 per ounce, the contract value would increase by $1,000 for a total worth of $51,000. Of course, when using leverage, the opposite is also just as true. If gold prices drop by $1 per ounce, the contract value would decrease by $1,000 to $49,000. The volatility of the price of gold lends itself to the possibility of sizable profits as well as substantial losses by investing in gold futures contracts.

blog comments powered by Disqus
Scottrade