World events have put gold back in the spotlight. In fact, on 6th January 2020, the price of gold reached its highest level since April 2013 ($1,590.90 per ounce). It then quickly dropped back to “just” $1,568.80 per ounce. With all the attention gold is receiving at the moment, you may be asking yourself if you should be looking at investing in gold and, if so, how you should go about it. Here is a quick guide to what you need to know.
Gold versus inflation versus interest rates
Inflation is the rate at which prices increase (its opposite is deflation). There are various ways to measure it according to the purpose for which the measure is being used. For example, in the UK the Consumer Price Index tracks the prices of an “average” basket of goods and is often the measure used to determine wage increases, especially in the public sector. It’s also possible to track inflation across particular sectors (such as property) or specific assets (such as gold).
As inflation goes up, so prices, in general, go up and so the price of gold specifically tends to go up. For the most part, some level of inflation is seen as both necessary and desirable. For example, in the UK, there is an official inflation target of 2% (with a 1% margin of error either way). If inflation becomes excessive, however, governments and/or central banks can increase interest rates in the hope that better returns on cash deposits will encourage people to save rather than spend and that if it does it will reduce demand and hence lower prices and inflation.
If inflation is low and interest rates are high, gold neither increases rapidly in value nor earns an income. This means that investors who continue to hold it lose out both on capital gains and interest payments. They may have other reasons for holding it (for example long-term faith in the market. general prestige or a desire to have something made out of it for themselves), but the chances are that, as a pure investment, gold will be being solidly outperformed by many other options.
Even when inflation is high, gold may not be the best option for hedging against it. For example, real-estate can also act as a hedge against inflation and can produce both capital gains and an income. That said, investing in real estate, especially residential buy-to-let can raise many legal issues, whereas investing in gold tends to be fairly straightforward.
The practicalities of investing in gold
There are three main ways to invest in gold. You can buy physical gold, buy shares of an exchange-traded fund (ETF), an exchange-traded note (ETN) or an exchange-traded commodity (ETC).
Buying physical gold may be appealing in theory but it’s important to think about the practicalities, especially storage and security. If you don’t fancy dealing with this, you can still invest in gold via exchange-traded funds, notes and commodities. These are all variations on the same theme.
ETFs either hold the underlying commodity (in other words they are backed by physical deposits of gold) or buy/sell futures contracts on the underlying commodity. ETNs are debt notes underwritten by a bank and linked to a market index or other benchmark, such as the price of gold. When they mature, the ETN owner receives a payment which reflects the price of the index/commodity on that specific day.
ETCs are a hybrid of ETFs and ETNs. They are debt notes, but they are also backed by collateral (in this case physical deposits of gold), which should eliminate the risk of the underwriter defaulting on the debt.