Is There A Right Way To Invest In Gold?

By Asher Hawkins | March 25, 2010 AAA
Is There A Right Way To Invest In Gold?

Many financial experts these days are advising folks put at least some of their money into gold as a hedge against inflation, economic collapse or merely for a bit of diversification. The question is: how, exactly? (Find out why so many investors go gaga for gold in 8 Reasons To Own Gold.)

There are plenty of ways to invest in gold, including stock-market shares that allow investors to profit from increases in the price of gold. But perhaps the most vocal proponents of the precious metal are those who say that anything less than physically getting your hands on a hunk of the stuff is a waste of time.

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"I'm looking at a crisis in the next year or years ahead where the U.S. dollar becomes effectively worthless," says economist John Williams, head of the website Shadow Government Statistics. "For someone looking to preserve his or her wealth against a serious inflation probability down the road, I would look at holding some physical gold."

Williams himself prefers gold coins, like South African krugerrands, because if financial Armageddon really does hit the U.S. they'll be easier than gold bars to exchange for vital goods and services. (Another of Williams' emergency currency suggestions: the mini bottles of liquor typically sold on airplanes; his research of countries that have experienced hyperinflation showed that these were easiest to barter with when currencies became worthless.)

"If you have severe inflation, gold takes on value as a barterable commodity," Williams says. "And if your gold is sitting some place in London, that's not going to help you much if you need it."

He's referring to the top-secret London-based vaults that hold a large amount of the planet's mined gold, much of it the subject of speculation by investors who will never lay hands on it. The British capital is the epicenter of gold investing, thanks to the London Bullion Market Association, officially created in 1987 to formalize the over-the-counter metals trading that has been going on in the city for centuries.

Perhaps the premier gold vault in London is that maintained by banking giant HSBC (NYSE:HBC). Whether they know it or not, countless U.S. investors own pieces of gold stored in there because it houses the assets of the SPDR Gold Trust (NYSE:GLD) exchange-traded fund. With gold an increasingly popular investment in an uncertain economic climate, the SPDR Gold Trust has become the world's second-largest ETF with a market value of $38 billion.

We asked Jason Toussaint for some details on this mysterious facility. He's director of investments at the World Gold Council, which oversees management of GLD. The HSBC vault stores the ETF's 1,100 metric tons of gold.

"I can't tell you exactly where the HSBC vault is, but it's in London. I can't say whether it's above or below ground, or describe its layout," he says. "But I can tell you it is the most state-of-the-art, advanced vault facility in the world, as far as I'm aware. The security procedures and emergency armed response plans are state-of-the-art as well."

Here's what happens when you buy a share of GLD. Whatever broker-dealer you use trades in "baskets" of 100,000 GLD shares and has a standing trading account with the GLD trust. Once a broker is ready to place an order for one basket, it alerts GLD's overseers. In London, staff at the HSBC vault credit the broker's account with 100,000 shares worth of gold (one GLD share is currently worth $106.) Then, they take physical gold they have on hand and move the correct amount to the area of the vault where GLD's gold is located. Through this process, GLD ensures that each of its shares is backed up by physical gold.

As GLD has gained popularity, some have expressed concern that it didn't hold enough physical gold to back up the shares it was issuing. GLD hired British commodities analysis firm Inspectorate International to conduct semi-annual inventories of the GLD store and has been posting the firm's findings on its website.

"All of the gold is there, in physical form," Toussaint promises.

Another fear regarding GLD: that the gold bars in the HSBC vault are filled with Tungsten, a decidedly less valuable metal. Toussaint says that's hogwash. "Anytime gold physically enters or leaves their vault, it's inspected through various means."

Here's the more relevant fear for would-be gold investors: that its recent dramatic price increase points to the formation of an asset bubble that will eventually pop.

Gold bulls dismiss all the bubble talk. Economic uncertainty, they argue, will continue to make gold a hot investment, with GLD among the most popular means of participating. What about investing in stocks of gold mining companies? Hard to predict how they'll perform: Shares in Barrick Gold (NYSE:ABX), for example, are down nearly 30% since the beginning of 2008, while the price of gold is up 30% over the same time frame.

What of holding physical gold, as Williams advocates? Too much trouble and expense for the average investor. You've got to worry about finding a dealer who won't rip you off, and, after that, storage and insurance for your valuable commodity.

"The bottom line is that there's no right or wrong way to invest in gold," Toussaint says. "But buying bars and coins is an inefficient transaction in many people's minds."

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