In the past, investing in gold was difficult for individual investors. You could buy the actual spot commodity in the form of coins and bullion or you could speculate in the futures market. Both alternatives were unpopular and expensive for most individual traders. However, investors now have access to gold investments - learn how to do it in your brokerage account.
Gold Investment through Gold Mining Stocks
There are a plethora of listed gold companies. Be aware that while a gold company’s stock price is linked to the price of gold, as it represents a major revenue stream, it is not a “pure play” on gold; it’s unlikely that a company’s value will directly replicate the price of gold.
Gold companies can be divided into two generic groups: “Juniors” and “Majors”. Each category has company-specific characteristics that impact its value. Generally, Juniors focus on exploration and are riskier than Majors, which typically are already in the mining and production phase. A Junior gold mining stock can be thought of as an option play on the likelihood of striking gold and getting bought out by a gold Major. Junior gold mining stocks do, however, typically rely heavily on credit, a key risk when credit markets are under duress. In comparison, gold Majors offer the possibility of operational leverage through gold price appreciation. The theory being that costs to produce gold are relatively fixed, such that gold price appreciation expands margins and the bottom line. In reality, such costs have not been fixed – many stakeholders have wanted a piece of the pie, from increased taxation to increased wages. Gold production is also extremely energy intensive, meaning costs are closely tied to the price of natural resources, such as oil, which has been elevated.
Complicating things further, many companies may not focus exclusively on gold. Some may also focus on other precious metals or minerals, such as silver, palladium or diamonds. If you invest in these companies, you may end up with a wider exposure to precious metals and minerals than just gold. Like any company, management will also have a large impact on the value of a gold mining company’s stock price. Good and bad management decisions can have a larger impact than the price of gold and in some instances may make or break your investment. Above all, make sure you know enough about a company to make an informed decision before investing.
If these reasons have you interested in adding gold mining stocks to your portfolio, a few top companies to consider are Barrick Gold Corp (#ABX), Randgold Resources (#RRS), Newmont Mining (#NEM), Royal Gold Inc. (#RGLD) and Goldcorp Inc (#GG). All four could benefit if gold prices rally, so open a brokerage account to learn more about them and start investing.
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Gold Mining Fund - Basket of Golden Eggs
Don’t have the time to research, but still want to invest in gold mining companies? Similar to gold stocks, gold mining mutual funds and gold mining Exchange-Traded Funds (Gold Mining ETFs) are not a “pure play” on gold, but rather invest in a broad basket of gold mining companies. This makes it easier to access a wide range of gold mining companies with one investment. Many will focus specifically on gold Juniors or Majors, as described above. Most Gold Mining ETFs and mutual funds are easy to purchase directly through a broker.
The manager of the Gold Mining ETF or mutual fund makes all the investment decisions independently, so there is no need to research companies. For this convenience, Gold Mining ETFs and mutual funds charge an expense ratio. The expense ratio is generally lower for Gold Mining ETFs because they often aim to track a static basket of gold stocks. On the other hand, mutual funds typically offer active management, rotating in and out of select securities as the manager deems appropriate. For this reason, mutual funds’ expense ratios are typically higher, and some may also charge front-load and/or back-load fees in addition to an annual expense ratio. As with any investment product, make sure you are aware of any and all fees before investing.
Overall, when considering an investment in gold stocks or gold stock funds, you should understand that neither will give you direct exposure to the price of gold. Instead, you will gain exposure to a company or companies that operate in the gold mining industry.
Traders can play individual gold miners profitably if they do their homework but sector exchange traded funds (ETF) offers an easier alternative, with broad exposure to the industry at different capitalization levels.
A few top mining funds to consider are gold bullion ETF VanEck Vectors Gold Miners ETF (#GDX), or Direxion Daily Gold Miners Index Bull 3X Shares ETF (#NUGT).
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Open-End Gold Trusts - Fractional Ownership
We’re talking about SPDR Gold Shares ETF (#GLD), iShares Gold Trust ETF (#IAU), and Physical Swiss Gold Shares ETF (#SGOL) to name a few. By owning shares in an exchange-traded opened gold trust, you have fractional ownership in the underlying gold. The trusts are called open-end because gold shares are issued and redeemed to accommodate investor demand. As a result, open-end trusts closely track the price of gold. There are a number of options available with relatively low expense ratios. Different funds may hold physical gold in different locations – from London to New York, even Singapore.
If a key priority of yours is to invest in physical gold, but like the convenience of investing in gold through an exchange, make sure that is clearly stipulated in the fund’s prospectus to ensure the trust uses no derivatives. If you’re interested in taking delivery of the physical gold, make sure you are aware of any limits imposed before you invest, as some funds may set fairly high requirements that could preclude you from accessing the underlying gold you own. These details can be found in any fund’s prospectus.
Overall, open-end gold trusts may offer an effective and relatively inexpensive way to invest in gold.
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Gold Derivatives - The Best Risk/Reward Potential
Derivatives traded on exchanges settle in a central clearinghouse that matches buyers and sellers. Gold derivatives are bilateral contracts that have more flexible structures and fractional investment requirements.
Derivatives trade on margin. The initial margin – or cash deposit paid to the broker – is a fraction of the price of the underlying contract. Consequently, investors can achieve notional gold value considerably greater than their initial cash outlay. While this leverage can increase return-on-investment, it also increases the chance for significant losses in the event of an adverse price movement in gold.
Gold margin trading offers some of the best risk/reward opportunities of any ﬁnancial market IF (big if here) you know how to exploit it. The availability of leverage, meaning the use of borrowed funds to control large blocks of troy ounces and thus magnify gains and losses, creates the unmatched proﬁt potential for those with limited trading capital IF (again, really big IF here) they learn how to control the downside risk.
For example, with 500:1 leverage, a 1 percent move means 500 percent proﬁt. It also means a 100 percent loss.
Understanding and controlling this risk, and knowing how much is appropriate in a given situation, is what distinguishes the winners and professionals from the losers on whom they feed.
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In Sum, How To Invest In Gold
Ultimately, when investing in gold, first ask yourself whether you want to track the price of gold or whether you’d prefer to have exposure to gold-related companies. Gold mining stocks and gold mining funds provide exposure to the value of gold companies, not directly to the gold price. The other options discussed aim to track the price of gold. Once you have made a decision, weigh the pros and cons of the various available options.
Final nugget of wisdom from an old English proverb: “when we have gold we are in fear when we have none we are in danger.”
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