Gold Bullion, Coins & Paper

For simplicity this article addresses investing, buying and storing gold, however much of the information also applies to other precious metals (e.g. silver and platinum).

It is true many investors are averse to gold because, as Warren Buffet argues, it’s an unproductive asset. Whereas equities and property are useful and provide a return, gold “doesn’t do anything but sit there”. Consequently, from his point of view it has little inherent value.

So why do some people ignore the advice of the world’s most famous investor and buy gold? In short, they believe it has a valuable role to play in protecting their wealth and diversifying their portfolio.

  • Back in 1971 the equivalent of 700 ounces of gold (USD $25,000) was enough to purchase a family house. That amount of cash today would hardly pay for a deposit, whereas 700 ounces of gold, worth approximately USD $875,000 is still enough to buy you a house.
  • Gold tends to have a low correlation to ‘risk’ assets, that is, it tends to go up in value when other asset classes go down. In this way, it can play an effective role in mitigating overall losses during the downside of the business cycle.
  • Gold, like all precious metals, may be used as a hedge against inflation, deflation or currency devaluation.
  • A unique feature of gold is that it has no default risk, but the more money that is pumped into an economy (ie money printing) the less value the currencies have.
  • Today the argument for an allocation to gold is strengthened by uncertainty on macroeconomic and geopolitical fronts ie there is significant short-term risk in ‘black swan’ events… unforeseen developments with the power to shock markets.
  • History shows that in extreme circumstances many investors join a ‘flight to quality’.
  • There are no limits on personal gold holdings in Australia. Therefore should we choose we are permitted to buy as much as we want.
  • Gold is readily accessible in the form of bullion, coin, warrants or Exchange Traded Funds, servicing ‘mum & dad’ investors through to Self-Managed Super Funds, institutional and sovereign buyers.

Factors influencing the Gold price

Supply and Demand

The price of gold is driven by supply and demand, including speculative demand. However most of the gold ever mined still exists in accessible form today, such as jewellery, nuggets, coins or bullion.

Warren Buffett has said that the total amount of gold in the world that is above ground could fit into a cube with sides of just 20 metres, however estimates for the amount of gold that exists today vary significantly and the exact amount is unknown.

Given the quantity of gold stored above ground compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production.

According to the World Gold Council, annual mine production of gold over the last several years has been allocated 80% (approximately) to jewellery / industrial / dental production, with the balance going to retail investors and exchange traded gold funds.

Central banks

Central banks and the International Monetary Fund play an important role in the gold price as they are at times major buyers or sellers of gold, although they do not usually announce purchases or sales in advance.

It is generally accepted that the price of gold is closely related to interest rates. As interest rates rise, the general tendency is for the gold price, which earns no interest, to fall, and vice versa. As a result, the gold price can be closely correlated to central banks policy decisions on interest rates. For example, if market signals indicate the possibility of prolonged inflation, central banks may decide to raise interest rates, which could reduce the price of gold but this does not always happen as the price of gold is also influenced by a number of macroeconomic variables such as the price of oil, the use of quantitative easing, currency exchange rate movements, returns on equity markets etc.

Jewellery and industrial demand

Jewellery and industrial demand consistently accounts for approximately 80% of annual gold demand, with China and India being the largest consumers.

Gold jewellery recycling

In recent years the recycling of second-hand jewellery has become a multibillion-dollar industry. The term “Cash for Gold” refers to offers of cash for selling old, broken, or mismatched gold jewellery to local and online gold buyers. There are many websites that offer these services.

However, there are many companies that have been caught taking advantage of their customers, paying a fraction of what the gold or silver is really worth, leading to distrust in many companies.

Does Gold make sense for your investment portfolio, if so how much?

Althought there is no right or wrong answer as to how much, we do know that most advisors who support the role of gold in a portfolio generally recommend an allocation of somewhere between 1% and 10% to help provide diversification and ‘insurance’ against inflation.

The remainder of this aritcle assumes you have decided to buy some gold for your portfolio.

‘Physical’ or ‘paper’ gold?

The answer depends on the amount of gold you’re going to buy, and what you’re going to do with it.

If you want to buy several ounces or more, then gold bars may be the way to go. Storage is easy and bars are a cost efficient way to purchase gold due to the casting process.

Physical – Bars

Bars generally carry lower price premiums than gold gold coins. However larger bars carry an increased risk of forgery due to their less stringent parameters for appearance. While gold coins can be easily weighed and measured against known values most bars cannot and therefore gold buyers often have bars re-assayed (at no small cost).  Larger bars also have a greater volume in which to create a partial forgery using a tungsten-filled cavity, which may not be revealed by an assay. Tungsten is ideal for this purpose because it is much less expensive than gold, but has the same density (19.3 g/cm³).

Efforts to combat gold bar counterfeiting include kinebars which employ a unique holographic technology and are manufactured by the Argor-Heraeus refinery in Switzerland.

Physical – Coins

Gold coins are a common way of owning gold. Gold coins are priced according to their fine weight, plus a premium based on supply and demand as opposed to numismatic gold coins, which are priced mainly by supply and demand based on rarity and condition.

Both coins and ingots attract a premium above the gold spot price. This is because they’re a decorative item. Put simply, they cost more to cast and that cost shows up in the price you pay and they make nice gifts.

Unlike gold bars, which only come in sizes of an ounce or higher, coins and ingots are cast as low as 1 gram.

The sizes of gold coins range from one-tenth of an ounce to two ounces, with the one-ounce size being most popular.

The South African Krugerrand is the most widely held gold bullion coin, with 46 million troy ounces (1,400 tonnes) in circulation. Other common gold bullion coins include the American Buffalo, American Gold Eagle,  Australian Gold Nugget (Kangaroo), British Sovereign, Canadian Gold Maple Leaf, Chinese Gold Panda, French Napoleon or Louis d’Or and Malaysian Kijang Emas.

Coins may be purchased from a variety of dealers both large and small but beware fake gold coins are common and are usually made of gold-layered alloys.

Paper – Exchange Traded Products

Gold exchange traded products may include exchange traded funds (ETFs), exchange traded notes (ETNs), and closed-end funds (CEFs), which are traded like shares on major stock exchanges. 

The first gold ETF, Gold Bullion Securities (ticker symbol “GOLD”), was launched in March 2003 on the Australian Stock Exchange, and originally represented 0.1 troy ounces (3.1 g) of gold.

Gold exchange-traded products (ETPs) represent an easy way to gain exposure to the gold price, without storing physical bars. However exchange-traded gold instruments, even those that hold physical gold for the benefit of the investor, carry risks beyond those inherent in the precious metal itself. For example, one of the most popular gold echange traded products (GLD) has been widely criticised and even compared with mortgage-backed securities due to features of its complex structure.

Typically a small commission is charged for trading in gold ETPs and a small annual storage fee is charged. The annual expenses of the fund such as storage, insurance and management fees are charged by selling a small amount of gold represented by each certificate so the amount of gold in each certificate will gradually decline over time.

Paper – Warrants

Perth Mint Gold (PMG) is a warrant providing a right to 1/100th of a troy ounce of gold created by the Perth Mint, is physically backed and West Australian government guaranteed.

Trading on the ASX under the code PMGOLD its price closely tracks the international over-the-counter market spot price of gold in Australian dollars and can be redeemed for physical gold coins or bars, with the option to take delivery, excercisable at any time.

Paper – Certificates

Gold certificates allow investors to avoid the risks and costs associated with the transfer and storage of physical gold (such as theft, large bid-offer spread and metallurgical assay costs) by taking on a different set of risks and costs associated with the certificate itself (such as commissions, storage fees and various types of credit risk).

Banks may issue gold certificates that are allocated (fully reserved) or unallocated (pooled).  Unallocated gold certificates are a form of fractional reserve banking and do not guarantee an equal exchange for metal in the event of a run on the issuing bank’s gold on deposit.  Allocated gold certificates should be correlated with specific numbered bars, although it would be difficult to determine whether or not a bank is improperly allocating a single bar to more than one party.

Paper – Derivatives, Contract for Difference (CFDs) and Spread Betting

There are other, perhaps more complicated and inheritently riskier ways of indirectly investing in gold via derivatives, such as gold forwards, futures and options that currently trade on various exchanges and over the counter directly into the private market (OTC) around the world, however this article does not address these alternative options.

If you have purchased physical gold, where you are going to keep it?

Do you want the gold dealer to store your investment for you? Do you want to keep it in a safety deposit box? Or would you like to store it at home?

In Australia private investors can’t insure physical gold, so we don’t recommend keeping it at home.  However we do understand an attraction for many gold investors is that they can and do keep their investment at home.  In which case we’d like to think it was well hidden and in a top quality safe.  This by itself can be quite an expensive item.

My son is a qualified locksmith and he once opened a locked safe in front of me with one hit of a rubber hammer in the right spot and the door popped open.

If you do choose to ‘hide’ gold at home it wouldn’t be wise for anyone to know.

Arranging storage through your gold dealer is a popular option.  Places like the Perth Mint have both an allocated and unallocated storage offering.  Meaning if you don’t take physical delivery of your gold, you can keep it stored with them, either with your name on it or not.

If you have allocated storage this means the gold dealer writes down the serial numbers of the gold bars next to your name, those gold bars are now allocated solely to you.

Unallocated storage is where the amount of gold you purchased is stored in a pooled vault. So you don’t have any serial numbers allocated, rather just an amount of gold set aside for you.

Finally you can take physical delivery of the gold bars and pay to have them stored in a security deposit box that you have access to at your leisure.

Which storage method you choose is up to you, however there are different fees charged for each method and ultimately it’s about choosing the option you are most comfortable with.

Where do you buy Gold from?

The following companies based in capital cities are the major gold dealers in Australia: The Perth Mint, ABC Bullion, Gold De Royale, Gold Stackers and City Gold Bullion.  Generally they will arrange shipping to you but you must be at the other end to sign for the gold.

Note: Gold can be purchased on eBay and other on-line gateways but this is not recommended.  The risk of purchasing fake coins or bullion is very real.  Whereas when you buy from a reputable dealer the purity of the gold is a known factor.

Gold Mining Companies

Instead of buying physical gold itself, investors can also buy shares in gold mining companies.  If the gold price rises the profit of the gold mining company could be expected to rise along with the worth of the company and presumably the share price too. However, there are many factors to take into account and it is not always the case that a share price will rise when the gold price rises. Mines are commercial enterprises and are subject to both positive and negative influences, such as flooding, subsidence, structural failure, theft, corruption, management, publicity, nationalisation, new finds, veins running out, third party risk etc. Such factors can and will influence the share price of mining companies.

The price of gold bullion is volatile, but unhedged gold shares and funds are even more so. This additional volatility is due to the inherent leverage in the mining sector. For example, if you own shares in a gold mine where the costs of production are $600 per ounce and the price of gold is $1,200 the mine’s profit margin will be $600. A 10% increase in the gold price to $1,320 per ounce will push that margin up to $720, which represents a 20% increase in the mine’s profitability, and possibly a 20% increase in the share price. Furthermore, at higher prices, more ounces of gold become economically viable to mine, enabling companies to add to their production. Conversely, share movements also amplify falls in the gold price. For example, a 10% fall in the gold price will lead to a 20% fall in the mine’s profitability and possibly a 20% decrease in the share price.

For this reason many gold mining companies hedge the gold price up to 18 months in advance. This provides the mining company and investors with less exposure to short-term gold price fluctuations, but reduces returns when the gold price is rising.