Last Updated Dec 18, 2009 2:36 PM EST
This article was updated on November 10, 2009.
In the past couple of years you've seen a lot of once solid economic assets crumble. Your home's value. Your 401(k). Your confidence that the world's bankers know what they're doing. At a time like this — especially now that gold is hitting record levels — it's not hard to make a case for owning gold, the investment of choice when the world's gone bonkers.
In the disastrous year of 2008, gold performed exactly as advertised. Even as the S&P 500 dropped nearly 40 percent and faith in paper money and government promises shriveled, gold held its value and then some, rising 4.3 percent. That cemented its reputation as, to quote financial planner and MoneyWatch blogger Charlie Farrell, a "financial-panic hedge." It also led many investment advisers to resuscitate the on-again, off-again recommendation that you keep about 5 percent of your portfolio in gold. "I recommend gold more as a form of insurance than as an investment," says Loyd Stegent, CPA and director of financial planning at Cornelius, Stegent & Price in Houston. "Gold usually comes to the rescue when financial assets are in crisis."
The real outlook for gold is more complicated, however. So before you sign away 5 percent of your portfolio on a financial-panic insurance policy, make sure you understand exactly what you're getting.
The Case for Gold
The fundamental case for owning gold centers on its history as a store of wealth that is impervious to the ravages of time, inflation, and politics. The metal more than doubled over the past five years through March, while the S&P 500 lost a fifth of its value. Gold has proven itself something of an inflation hedge, too. During the Great Inflation of 1973 to 1982, gold shot up 17 percent annually on average—about twice the rate of consumer prices. If history is any guide, the massive economic stimulus packages here and abroad are exercises in printing money, which could lead to higher inflation. (Keep in mind, though, that gold isn’t the only inflation hedge; federally guaranteed Treasury Inflation-Protected Securities, or TIPS, pay interest and can be bought without brokerage charges through TreasuryDirect.gov.)
The Case Against Gold
Gold has four flaws, however. First, it’s been a so-so investment over the past 30 years, compared with stocks and a broad measure of commodities. Second, its price can be highly volatile. No one confused gold with a safe harbor when it fell from $800 in early 1980 to about $300 two years later. At any price over, say, $850 an ounce, you have to wonder how much easy money is left. Third, gold offers no stream of income—it’s pure speculation. Fourth, fears about the financial system seem to be abating, so it may be late to buy gold as a panic hedge.
How to Buy Gold
- Rare or collectible numismatic coins:
Best left to hobbyists, since you really need to know the market to invest in them.
- Proof coins (premium versions of gold bullion coins):
They’re priced extravagantly.
- Fractional-ounce coins: They incur a higher markup than one-ounce versions. For example, a dealer recently sold a half-ounce American Eagle for $545, or the equivalent of $1,090 an ounce, while a one-ounce Eagle from the same dealer went for $973.
If you’d like to buy gold as a form of insurance to diversify your portfolio, the best ways are by purchasing gold coins, exchange-traded funds that buy the metal for you, or shares of gold-mining companies via gold mutual funds or stocks of the companies themselves.
Gold CoinsFor hard-core gold bugs and worst-case-scenario worriers, there is no substitute for owning a personal stash of the yellow metal. But this can be an expensive and somewhat complicated way to go. You pay a premium over gold’s spot price (the cash price quoted on commodity exchanges) when buying the coins and will likely want to rent a safe deposit box or buy a safe to hold them.
The simplest and cheapest way to purchase physical gold is by buying any of the most popular bullion coins: American Gold Eagles, Canadian Gold Maple Leafs, or South African Krugerrands. These legal tender coins are widely recognized and traded, in part because they’re guaranteed by their governments. Premiums fluctuate, so it’s best to buy one-ounce coins with the lowest surcharge. Krugerrands are usually the best value, since their premium tends to be lower than those on Eagles and Maple Leafs. In late April, when an ounce of spot gold was $892, a one-ounce Krugerrand went for $948 (roughly a 6 percent markup), a Maple Leaf for $951, and an American Gold Eagle for $973.
Shop around and compare prices from dealers. Start with major, legitimate Web sites such as Tulving, Gold Masters USA, and Monex Precious Metals. You can have the coins sent to you and store them in a home safe or your bank’s safe deposit box. Alternatively, you can order the coins shipped to a storage service such as First State Depository. First State charges a minimum of $240 per year, plus shipping fees.
You can often find the lowest markups if you buy 20 ounces or more.
What not to buy:
Gold Shares and Gold FundsBuying shares of gold-mining firms through gold mutual funds or individual stocks eliminates the nuisance of storing coins and the expense of the markup. Shares of gold-mining companies also offer something the metal can’t: dividends, which average a modest 1 percent.
On the other hand, gold share prices don’t behave the same way as the price of the metal itself. Mining stocks, after all, are paper assets that represent ownership in a business. So in a year like 2008, when fear about the banking system undercut virtually all securities except U.S. Treasuries, gold shares did not escape the taint of paper assets. While they held up better than most kinds of stocks, not one of the 21 gold funds tracked by Morningstar posted a gain during the worst of the crash.
Then there are the volatile swings in price, which are even more dramatic than for the metal itself. “Historically, gold stocks tend to move two to three times the move of the metal’s price—up or down,” says John Doody, editor of the Gold Stock Analyst newsletter. Soaring gains of 50 percent or more in one year can be followed by an equally large loss the next. Holding a basket of mining stocks in a gold fund—as opposed to putting all your gold stash in one individual stock—can mitigate some of the risk, because you won’t be buffeted by losses particular to a single mining company. But you’ll still be subject to the built-in propensity of gold-mining stocks to magnify the price swings of the metal itself. This type of fund isn’t for the faint of heart.
Most precious-metals equity funds require minimum investments of $1,000 to $2,500, although the amount is often lower for IRAs. But precious-metals funds, as a group, had a 15.8 percent annualized total return over the past decade, while the market as a whole essentially went nowhere. Some gold funds did even better. For example, First Eagle Gold Fund returned 19.8 percent.
Before investing in a gold fund, read its materials to learn which types of companies it likes to buy. Some funds focus on smaller stocks, which can offer better growth prospects than their larger-cap brethren but also greater risk. Fidelity Select Gold, for instance, favors larger, established players, while U.S. Global Investors World Precious Minerals concentrates on smaller companies.
Gold ETFsOf your three main ways to buy gold, exchange traded funds (ETFs) are probably the best choice if you’re looking simply for that financial-panic insurance policy. ETFs are investment trusts sold on stock exchanges. Think of them as mutual funds that hold the physical commodity, as opposed to collections of stocks of companies that mine it. As such, they reflect the price of gold bullion better than gold-mining stocks, with none of the hassle and markup of owning the metal directly. “For years, the smartest thing to do if you were afraid the sky was falling was to hold bullion,” says Jeff Seymour, managing director of Triangle Wealth Management in Cary, N.C.. “But that’s messy and complex, and I like simple, which is a gold ETF.”
The original and biggest gold ETF is the SPDR Gold Trust, with more than $2 billion of assets. It’s also the most liquid, with average daily trading volume of more than 20 million shares. But convenience has a price. In addition to brokerage fees for buying and selling, the costs of running an ETF add up. Although the price of gold rose about 66 percent over the three years through March, the SPDR Gold Trust climbed only 55 percent. To keep the price tag down for a gold ETF, use a discount broker and keep trading to a minimum.
You might want to hold a gold ETF in a tax-sheltered account, like an IRA. ETF shareholders are treated as though they own the gold directly, which means the IRS will tax capital gains at 28 percent if you hold the ETF for more than a year, well above the 15 percent rate for long-term gains on stocks.