Joining the rush for gold? Know your objective before jumping on the bandwagon.
The rapidly spreading coronavirus crisis, coupled with the oil market collapse, has triggered the onset of a global recession. As a result, the demand for gold as a safe haven asset has spiked dramatically. If you are among many investors who are trying to get hold of gold, you are likely to be disappointed at the news from bullion dealers that the metal is currently out of stock.
Before you join in the frantic gold rush, there are five things you need to know about gold investing.
1. INVESTMENT GOAL
Like investing in stocks, bonds or real estate, the first thing one needs to be clear about is the objective. This will help decide how to choose among various investment options. Historically, gold price is not highly correlated with stock price.
When stocks are in the bull market, gold tends to underperform the stocks. When the market plummets, gold price tends to go up. Therefore, gold can be added to one’s investment portfolio as a diversification strategy to reduce asset volatility and obtain a steady return in the long run.
Due to its safe-haven reputation, gold acts as a store of value protecting one’s wealth. Owning gold can also serve as a hedge against a drastic devaluation of fiat currencies. A case in point is the 1997 Asian financial crisis, when the currencies of many Asian countries suddenly collapsed. Gold priced in US dollars served as a hedge against rapidly depreciating currencies. It can now be traded around the clock throughout global financial markets.
Speculators aim to make a quick profit from gold price volatility. Their investment horizon is normally very short, ranging from within a day to several weeks. They normally do not trade physical gold. They prefer gold futures and exchange-traded funds (ETFs) due to high liquidity and ease of trade.
Gold bullion can be stored at home, in a safety deposit box managed by a bank, or with a dealer from which one buys gold. There are pros and cons associated with each option.
Home storage appeals to those investors who value privacy and do not trust other institutions holding their treasure. Downsides include theft risk and the inability to liquidate the asset quickly in the event of a sudden price spike.
Although safety deposit offers privacy and security, the supply of reliable operators may be limited. Investors have to incur storage fees.
The big advantage of dealers’ storage service is convenience. Investors do not need to worry about transportation risk. Trading becomes a breeze. However, it is important to protect against the dealer’s bankruptcy risk. To do so, investors should look for trustworthy dealers and have their bullion segregated from the dealer’s inventory.3. BARS V COINS
The simplest form is gold bars. They are in rectangular slabs of .999 pure gold, with weights ranging from 1oz to 1 kilo. Bars are easy to trade and hence appeal to a variety of investors such as governments, and institutional and private investors.
Coins are more popular among many retail investors. They are generally minted by government agencies that guarantee gold content, weight and purity. The well-known ones include American Gold Eagles, Canadian Gold Maples and Gold Britannias. Some coins have numismatic value due to their rarity and unique design.
4. PAPER GOLD
If investors do not like the inconvenience associated with owning and trading physical metal, they can consider gold ETFs. The two popular options are the SPDR Gold Trust and the iShares Gold Trust. Both ETFs are backed by gold bullion and hence closely track the movement of gold price. They trade like stocks with high liquidity. They are equivalent to owning bullion in terms of price protection against market volatility and inflation risk.
Buying gold mining shares is another choice. However, most large miners also mine other precious metals. Therefore, owning their shares is not the same as owning gold. The share price of mining firms does not move in tandem with gold, and sometimes goes in the opposite direction of gold price.
5. BEWARE OF RISKS
Gold investment involves risks. Gold price is not only determined by the normal interplay of supply and demand, but also subject to currency risk and speculative force.
For example, in recent extreme market swings triggered by the Covid-19 crisis, gold price plummeted by 11.78 per cent from March 9 to 18 due in part to a concurrent surge in the value of the US dollar. Another risky example is if investors had bought gold in 2011 or 2012 when its price was peaking, they would have suffered a big loss.
In summary, gold can serve as a hedge against market volatility and inflation risk. It has generated an annualised return of 5.81 per cent in the past five years, and an annualised 8.85 per cent in the past 15 years. Thus, it can be part of one’s diversified portfolio.
A key to control risk is to avoid buying at a high price, which usually occurs at the height of market turmoil. Contrary to popular belief, a good entry point is during a peaceful time when gold is “unwanted” and its price is low.
• The writer is dean’s chair and associate professor of accounting and finance at NUS Business School. The opinions expressed are those of the writer and do not represent the views and opinions of NUS.