Gold has been a substance of value for millennia, and remains valuable today with the price of one ounce of the precious metal surpassing $1,900 on January 20, 2023. Many investors seek to hold gold as a store of value and as a hedge against inflation, but it can be difficult and cumbersome to hold large quantities of physical gold. Security efforts are often put in place to prevent its theft which can also be expensive.
Fortunately, there are a number of ways to gain exposure to movements in the price of gold without physically holding it.
- If you want to add gold to your portfolio, you may find it difficult and extra costly to track down physical gold coins, bars, or pieces of jewelry.
- Luckily, investors can still add gold investments to their portfolio through derivative contracts whose prices track that of the precious metal.
- For those unable to trade derivatives, you can also purchase gold mutual funds or ETFs that track its price, or invest in the shares of gold mining stocks.
- Each option for investing in gold without physically holding it carries its own set of risks and advantages, and it is important to carefully consider these before making a decision.
- Factors to consider may include market risk, credit risk, liquidity risk, and management risk, among others.
It has been speculated that the earliest form of credit banking took place via goldsmiths who would store the gold of members of the community. In return, those depositing gold would receive a paper receipt which could be redeemed for their gold at some point in the future. Knowing that at any given moment only a small fraction of those receipts would be redeemed, they could issue receipts for a larger amount of bullion than they actually kept in their coffers. And thus a fractional reserve credit system was born.
Today, it is still possible to invest in gold receipts which can be redeemed for physical gold. Although most government mints do not deal privately with gold any longer, some enterprising private "mints" do. For example, the Royal Canadian Mint (not affiliated with the Canadian government) offers electronic tradable receipts (ETRs) backed by their vaulted gold, as well as collectible coins minted from precious metals. These ETRs can trade on an exchange or change hands privately and track the price of the gold that backs it.
While receipts are backed by gold and can be redeemed for it on demand, derivatives markets use gold as the underlying asset and are contracts that allow for the delivery of gold at some point in the future.
A forward contract on gold gives the owner of the contract the right to buy physical gold at some point in the future at a price specified today. Forward contracts are traded over-the-counter (OTC), and can be customized between the buyer and seller to arrange such terms as contract expiration and nature of the underlying (how many ounces of gold must be delivered and at what location).
Futures contracts operate in much the same way as forwards, the difference being that futures are traded on an exchange and the terms of the contracts are predetermined by the exchange and not customizable. Because forwards trade OTC, they expose each side to credit risk that the counterparty may not deliver. Exchange traded futures eliminate this risk. Often times, forward or futures contracts are not held until expiration and so physical gold is not delivered. Instead, the contracts are either closed out (sold) or rolled over to another new contract with a later expiration.
Call options can also be used to gain exposure to gold. Unlike a futures or forward contract which gives the buyer the obligation to own gold in the future, call options give the owner the right but not the obligation to buy gold. In this way, a call option is only exercised when the price of gold is favorable and left to expire worthless if it is not. In other words, the price paid for the option (known as the premium) can be thought of as a deposit for the right to buy gold at some point in the future for a price specified today (the strike price). If the actual price of gold rises above that specified price, the owner of the option will make a profit. If, however, the price of gold does not rise above the strike price, the buyer of the option will lose the premium – like losing a deposit.
Derivatives markets are efficient ways to gain exposure to gold and are generally the most cost-effective. They also provide the greatest degree of leverage. For the average investor, however, derivatives markets are unaccessible. Instead, a typical investor can gain exposure to gold via mutual funds or EFTs that buy gold which are traded like shares on stock exchanges .
The SPDR Gold Trust ETF (GLD) is popularly used; the investment objective of the Trust is for its shares to reflect the performance of the price of gold bullion. There are also leveraged gold ETFs that provide the owner with 2-times long exposure, ProShares Ultra Gold (UGL), or alternatively 2-times short exposure, Goldcorp (GG).
Gold Mining Stocks
While it may seem like a good way to gain indirect exposure to gold, owning the stocks of companies that mine for and sell gold, such as Barrick Gold (ABX) or Kinross Gold (KGC), may not give the investor the exposure to the precious metal that they wanted. The reason for this is that the majority of gold companies are in the business to make a profit based on the cost to mine for gold versus what they can sell it for. They are not in the business of speculating on its price fluctuations. Therefore, most gold companies hedge their exposures to gold price risk in derivatives markets, and owning shares of these companies mainly gives the investor exposure to the operating profit margins of that company.
Still, if an investor wants to own gold stocks to diversify an equity portfolio they may want to consider a gold miners ETF such as the Market Vectors Gold Miners (GDX).
What are the options for investing in gold without physically holding it?
There are several options for investing in gold without physically holding it, including:
- Gold mining stocks: You can invest in gold mining stocks, which represent ownership in a gold mining company and allow you to participate in the company's profits.
- Mutual funds or exchange-traded funds (ETFs) that invest in gold: These funds allow you to invest in a diversified portfolio of gold-related assets, such as gold mining stocks or gold futures contracts, without having to directly own physical gold.
- Gold-based savings plans or gold receipts: Some banks and financial institutions offer gold-based savings plans or gold certificates, which allow you to invest in gold without physically holding it.
- Gold futures contracts: You can also invest in gold through futures contracts, which allow you to buy or sell gold at a future date at a predetermined price. However, futures contracts are considered to be complex financial instruments and may not be suitable for all investors.
- Options on gold futures: You can also invest in options on gold futures, which give you the right (but not the obligation) to buy or sell gold futures at a predetermined price on or before a certain date. Options on gold futures are also complex financial instruments and may not be suitable for all investors.
How do gold mining stocks compare to investing in physical gold?
Gold mining stocks represent ownership in a gold mining company and allow you to participate in the company's profits. Investing in gold mining stocks can offer potential advantages over investing in physical gold, such as the use of leverage - meaning that the potential returns on your investment may be higher than the returns you could achieve by investing in physical gold. However, leverage also increases risk, as the potential losses on your investment may also be greater. Gold mining stocks can also help you diversify a broader portfolio, as they may be less correlated with other assets than physical gold. This means that gold mining stocks may be less affected by movements in other asset classes, such as stocks or bonds.
However, investing in gold mining stocks also carries its own set of risks. For example, the value of gold mining stocks is subject to changes not only in the price of gold, but also the operational and financial performance of the mining company. In addition, gold mining stocks may be more vulnerable to economic and political risks, such as changes in regulations or taxes, than physical gold.
Overall, investing in gold mining stocks can be a more complex and potentially riskier option compared to investing in physical gold. It is important to carefully consider the potential advantages and risks before making a decision.
Are there any risks to consider when investing in gold through indirect or alternative methods?
Investing in gold mining stocks can offer potential advantages over investing in physical gold, such as leverage and diversification, but it also carries its own set of risks, including market risk, credit risk, liquidity risk, and management risk.
Mutual funds or ETFs that invest in gold allow you to invest in a diversified portfolio of gold-related assets without directly owning physical gold, but they also carry their own risks, such as market risk and management risk.
Gold-based savings plans and gold certificates offer a way to invest in gold without physically holding it, but they are subject to credit risk and may not be as liquid as physical gold.
Gold futures contracts and options on gold futures are complex financial instruments that allow you to buy or sell gold at a future date at a predetermined price, but they carry the risks of market risk, liquidity risk, and the risk of loss due to margin calls. It is important to carefully consider the potential risks and advantages of any investment before making a decision.
The Bottom Line
Owning gold can be a store of value and a hedge against unexpected inflation. Holding physical gold, however, can be cumbersome and costly. Fortunately, there are several ways to own gold without keeping a physical stash of it. Gold receipts, derivatives and mutual funds/ETFs are all viable strategies to gain such exposure. Shares of gold mining companies, while seemingly a good alternative on the surface, may not give the gold exposure to investors that they want since these companies usually hedge their own exposure to price movements in gold using derivatives markets.