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The Comprehensive Schwab Guide to Buying and Owning Gold

Learn about why gold is considered to be so valuable as well as various vehicles that allow you to hold an interest in gold.

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Investors and traders have long held a great fascination with gold. Some of this fascination is no doubt related to the mystique that surrounds the yellow metal. Some of it is also due to the intrinsic value involved in holding a piece of essentially indestructible metal. In any event, due to its unique qualities, gold has long offered investors a one-of-a-kind investment opportunity.

In this guide we will discuss the reasons why this has been, why it remains so, and why gold will remain a unique investment opportunity far into the future. But even more importantly we will also detail a variety of investment vehicles available that can allow you to hold an interest in gold and to participate in bullish and/or bearish price movements in the world’s most renowned precious metal.

The decisions regarding if, when, and how to allocate investment capital to gold are personal ones. The purpose of this guide is not to tell you when to make such a commitment, nor to tell you which investment vehicle to choose. The goal of this guide is simply to provide you with a thorough understanding of:

  1. Reasons why an investment in gold may be right for you.
  2. Primary factors that can affect the price of gold.
  3. Commonly used investment vehicles for trading gold and their relative advantages and disadvantages.

After a thorough reading of this guide you should have the knowledge required to make intelligent decisions regarding investing in gold.

Why Investors and Traders Buy Gold

Before considering an investment in gold, it is helpful to have a clear understanding of the role that gold can play in your investment portfolio, and the unique opportunities that an investment in gold creates. You may choose to consider an investment in gold or gold-related assets for any or all of the following four reasons:

1. As a Store of Value in the Face of Uncertainty

Throughout the world, each country’s government creates and maintains its own fiat currency. The bills and coins they create are what most people think of when they think of the word “money.” Still, all of today's government-issued paper fiat currencies have no tangible value and are backed only by government decree.

Unlike paper currency, coins, or other assets, gold has maintained its value throughout the ages. Gold is not created by governments nor is its value dependent upon governments in order for it to retain certain intrinsic value. Unlike governments or other man-made entities, physical gold cannot go bankrupt and will never default on promises or obligations.

This has been the case for centuries and currently there is no reason to think this won’t be true for long into the future. Because of this, many investors believe in the idea of buying and holding gold as a store of value.

2. As a Hedge Against Inflation

Price inflation involves a persistent and/or substantial rise in the general level of prices for goods and services. Inflation is typically related to an increase in the volume of money and results in the loss of value of currency, or purchasing power.

When price inflation occurs, the price of commodities—i.e., real, tangible assets—tends to rise as well. Due in part to its indestructibility, gold is sometimes thought of as the ultimate store of value. As a result, gold has historically served as a useful hedge against inflation. Since World War II, the five years in which U.S. inflation was at its highest were 1946, 1974, 1975, 1979, and 1980. During those five years, the average real return on the Dow Jones Industrial Average was -12%, compared to +130% for gold.1,2

3. To Diversify an Investment Portfolio

Another reason to consider an investment in gold is simple, good old-fashioned portfolio diversification. While many investors tend to focus on stocks and bonds, the reality is that commodities are a viable asset class and are worthy of consideration as a part of any portfolio. Because gold is considered to be one of the pre-eminent commodities in the world, it serves as a common choice for inclusion in any well-diversified portfolio.

During times of uncertainty, inflation, and/or geopolitical tensions, stocks and bonds can decline in value as fear and uncertainty rises. During these times, exposure to commodities in general—and gold specifically—can serve as a useful hedge, as they may stand to increase in value while other asset classes are losing value.

4. To Attempt to Profit from Price Fluctuations

Gold has a history of registering some very large percentage price movements over time. Some traders may ignore all of the more fundamental reasons for trading gold and simply seek speculative profits. Traders looking for meaningful price movement can often find it in the gold market.

In the 1970’s, gold rallied roughly 490% in just three-and-a-half years before subsequently giving back 54% of that advance over the next two-and-a-half years. Over the course of a full decade, starting in 2001, gold rallied almost 600%. From there, the price declined by more than 40% over a three year period.3

Based on these large and often prolonged price swings, it is not at all surprising that many investors buy (and/or sell short) gold or gold-related assets in an effort to generate speculative profits. Also, as we will discuss shortly, it has never been easier for investors to participate in long-, intermediate-, and short-term price movements in the price of gold via a wide variety of investment vehicles.

Factors That Can Influence the Price of Gold

Before considering an investment in gold, it is helpful to become knowledgeable about some of the more prominent factors that can influence the price of gold. As with virtually any asset, there are multiple factors that can exert an influence on the price of gold at any given point in time. As a result, there is no one single factor that you can follow that will divine with certainty which way gold is headed next. Still, by monitoring a variety of influencing factors, you can make intelligent decisions regarding the timing of your gold investments.

Because gold is a physical commodity as well as a form of money, there are some factors that can influence the price of gold directly, while other factors may influence the price of gold inversely. This will make more sense after the following discussion.

Correlated Factors

1. Supply and Demand

Virtually every physical commodity in the world is affected by changes and trends in the supply and demand for that particular commodity. Simple economics teaches us that if there is a surge in demand—and/or a sharp decline in supply—for a given product, then the price of that product will typically rise in price and vice versa.

The supply of gold will fluctuate based on the overall level of gold mining production and also from the amount of gold that is recycled from old jewelry and other sources.

On the demand side of the equation, gold has been a valuable and highly sought-after precious metal for coinage, jewelry, and other uses since the beginning of recorded history. Though the largest demand for gold comes from those who use the metal to create jewelry, gold is also used to manage risk in financial portfolios and to protect the wealth of nations as central banks of various countries may at times acquire gold to support the value of their currency.

These diverse uses for gold mean that different sectors in the gold market may rise in prominence at different points in the global economic cycle. This self-balancing nature of the gold market means that, typically, there is a sustained base level of demand.

2. Inflation

As we mentioned earlier, price inflation—when it occurs—is a powerful reason to consider an investment in gold. During times of inflation, physical, tangible assets tend to rise in price. As gold bullion is often referred to as the “ultimate store of value”, there can be a strong surge of demand for gold during periods of inflation. This phenomenon occurred most notably in the late 1970’s. As the overall rate of inflation rose into double digits, the price of gold bullion soared over 700%.

Conversely, if inflation peaks and begins to decline sharply, a great deal of gold selling may occur as many investors unwind the positions they bought originally as a hedge against inflation. This aggressive selling and increased supply can serve to drive the price of gold bullion lower.

3. Geopolitics

Any number of unexpected world events can lead to shocks in world economics. Coups, wars, debt crises, political tensions, economic hardships, and so on can all lead to heightened tensions in the political and financial markets. The price of gold is typically positively correlated with rising geopolitical tensions. Quite often, the reaction in the price of gold to unexpected events is swift and pronounced. It should also be noted that waiting for an unforeseen event to occur and then buying gold often involves getting in “too late”, i.e., after the gold market has reacted to the news. As a result, and as future shocks are inevitable, some investors may feel compelled to hold a portion of their portfolio in gold on a long-term basis as a hedge against any variety of unforeseen events.

Inversely Correlated Factors

While the price of gold may react directly to changes in supply and demand, inflation, and geopolitical events, the price will often move inversely to the action among these three other influencing factors.

1. The U.S. Dollar

Generally speaking, the price of gold tends to move inversely to the value of the United States dollar. In other words, gold tends to decline when the U.S. dollar is strong and gold tends to rise when the U.S. dollar is weak. The inverse nature of the relationship between the U.S. dollar and gold bullion has been quite persistent for several decades. However, it should be noted that this is not an inviolable 1-to-1 inverse relationship, and gold and the dollar can and will both rise or fall in tandem at times.

2. The Stock Market

There is an old investment adage that states “money will flow to where it is treated the best.” To put it another way, various investment vehicles essentially compete with one another to attract investment dollars. The money can be used to buy stocks, bonds, or physical commodities such as gold. If the stock market is performing well and gaining ground consistently, there is an incentive to put money to work there and to eschew other investments such as bonds and gold.

On the other hand, when the stock market is weak, there is an incentive to move away from stocks and to pursue assets that move based on factors not related to the fundamentals that typically move stocks (sales, earnings, dividends, etc.). As the foremost perceived store of value, gold is a natural choice for many investors.

So in broad terms, when the stock market is declining, there is an incentive to invest in gold and vice versa.

3. Interest Rates

Though not as pronounced as the relationship between stocks and gold, the price of gold and the trend of interest rates (i.e., bond yields) have long held a mildly inverse relationship as well. This should not be surprising. As previously mentioned, various investment vehicles compete for investment dollars. As a result, if interest rates are rising and/or are at a high level, this draws investment capital away from gold as investors seek to lock in a given yield level by buying bonds. Likewise, if interest rates are falling, investors may have an incentive to move money away from bonds and into other assets such as gold.

Six Methods for Buying/Trading Gold

Now that we have discussed a variety of factors that may influence the price of gold, it is time to turn our attention to the various investment vehicles you might consider should you choose to participate in the movement of the price of gold.

While each of the six instruments that we will discuss is designed to track the price of gold—or a related asset, such as gold mining companies—each instrument also comes with its own unique set of advantages and disadvantages. The following discussion of each of these instruments is intended to help you clearly understand the unique nature of each instrument and the potential risks and rewards associated with each instrument.

1. Gold Futures Contracts

A gold futures contract represents a binding agreement between two parties to trade a specific amount of gold at a specific price on a specific date in the future. In the futures markets, this future date is referred to as the “settlement day.” At the time the agreement is made, the buyer does not immediately pay the agreed upon price and the seller does not deliver any gold. If an actual exchange of cash and gold is to take place between the buyer and seller, it will occur on the settlement day.

Most futures traders use this delay between agreeing to terms and the actual settlement day to speculate that the price of gold will move in their favor prior to settlement day. In the majority of (though not all) cases, the goal of a futures trader is to exit their position prior to settlement day rather than to actually receive or deliver actual physical gold bullion. By closing their futures position prior to settlement day, the trader can simply settle the gain or loss that has accrued based on the change in the price of gold since the original position was entered.

Futures Contracts Available and Contract Value

Gold futures are primarily traded at three different exchanges: NYSE-Liffe, the Tokyo Commodity Exchange, and the COMEX Division of New York Mercantile Exchange, where the most heavily traded gold futures contract is traded under the ticker symbol GC. The primary contract months are February, April, June, August, October, and December.

Each COMEX gold futures contract is for 100 ounces of gold bullion and its price is quoted as dollars per ounce. The minimum “tick size” is $0.10 per ounce and each tick is worth $10 making each $1 in current price for a COMEX gold futures contract worth $100 in terms of contract value. For example, if a given gold futures contract is trading at $1,000.00 an ounce, then the dollar value for that contract would be 1,000 times $100 per ounce, or $100,000. If the price of the contract were to rise 10 ticks (10 X $0.10) to $1,001.00 per contract, then because each tick is worth $10 in value, the dollar value for that contract would rise from $100,000 to $100,100.

If you buy a gold futures contract at a price of $1,000 per ounce and subsequently sell that contract (rather than holding it until settlement day) at a price of $1,001.00 per ounce, you will earn a profit of $100 (10 ticks X $10 per tick). If you buy a gold futures contract at a price of $1,000 per ounce and subsequently sell that contract at a price of $999.00 per ounce, you will suffer a loss of $100 (-10 ticks X $10 per tick).

It should be noted that if you expect the price of gold bullion to decline instead of rise, you can sell short a gold futures contract just as easily as a trader expecting a rise in the price of gold can buy a gold futures contract. After selling short a gold futures contract, you will attempt to buy back the contract and cover the short position at a lower price than that which you originally sold it short. If you are able to buy back the contract at a lower price than that at which you originally sold short, you will earn a profit. For example, if you sold short a gold futures contract at $1,000 an ounce and later bought it back at $990 an ounce, you would earn a profit of $1,000 ($100 per point X 10.00 point).

Understanding Futures Margin Requirements

One of the things that make futures trading unique is the amount of “leverage” involved. In order to buy or sell short a futures contract, you do not need to put up the full dollar value of the contract at the time a trade is entered. Instead, you only need to hold in your futures trading account the exchange-required “initial minimum margin” amount. While the amount required can vary widely from time to time, initial minimum margin is typically between 2% and 10% of the actual dollar value of the futures contract.

Before presenting an example, it should be noted that the word “margin” has a different meaning in the futures markets than it does in the stock market. In stock trading, trading “on margin” means putting up half of the cost of the stock shares in a stock margin account and borrowing the rest from the stock brokerage firm. In futures trading, a “margin” deposit essentially represents a “good faith deposit” required of a trader in order to enter into a long or short position in a given futures contract.

After the trade is entered, the trader must maintain a minimum account value known as the “maintenance margin” level. If the account value drops below the maintenance margin level, the trader will need to enter money into the account immediately to get back above that level or the brokerage firm may liquidate the open position.

Initial and maintenance margin requirements can vary over time as exchanges may occasionally raise or lower these requirements in the face of rising and/or declining volatility and rising or falling contract values. To understand the impact of trading futures contract using margin, and to better appreciate the degree of leverage involved in futures trading, let’s consider an example using gold futures.

Gold Futures Example:

  • A gold futures contract is trading at a price of $1,100.00 an ounce. Each $0.10 tick is worth $10 so each $1.00 in price is worth $100. As a result, the contract value is $110,000.00 (1,100 X $100).
  • The margin requirement at the time the trade is entered is $4,000 (but remember that this amount can change over time). In order to buy one gold futures contract, you must have a minimum of $4,000 in your futures trading account.
  • To put it another way, you are able to control $100,000 worth of gold by putting up just $4,000, or 4% of the value of the contract. This represents leverage of 25-to-1 ($100,000 / $4,000).

Relative Advantages and Disadvantages of Trading Gold Futures

There are two potential primary advantages associated with using futures contracts to trade gold. The first is that a futures contract is a direct play on the price of gold. Unlike options or gold mining stocks, which we will discuss later and which trade “based on” fluctuations in the price of gold or some derivative, gold futures will rise or fall in line with fluctuations in the price of cash gold bullion. For a trader who believes that the price of gold is about to rise (or fall), a position in a futures contract offers the opportunity to participate directly in the anticipated price movement.

The other potential advantage rises from the amount of leverage involved in trading a futures contract. Let’s go back to our earlier example of putting up $4,000 in margin money to buy a gold futures contract with a contract value of $100,000. If you enter this position and gold rises in price by 4%—from $1,000 to $1,040—then the value of the futures contract will rise from $100,000 to $104,000. This $4,000 increase in value represents a 100% gain on the $4,000 of margin money put up to enter the trade. The bottom line is that a futures trader who successfully times his or her entries and exits has the potential to generate above-average percentage gains.

The primary disadvantage to trading gold futures contracts is that the leverage involved can serve as a double-edged sword. While a well-timed trade can generate a large percentage gain, a losing trade can just as easily generate a large percentage loss. In fact, unlike stock trading—where the most that a trader can lose on a trade is the amount they put into the trade—in futures trading it is possible to lose more than the amount initially committed to enter a given trade.

Going back to our example again, a trader puts up $4,000 in margin money in order to buy a gold futures contract with a contract value of $100,000. The maintenance margin level is $2,500. If the price of gold declines today by 5%, then the value of the futures contract will decline from $100,000 to $95,000. The trader now has an open loss of $5,000 which exceeds the $4,000 in margin he or she put up to enter the position. The broker will issue a “margin call” and require the trader to deposit enough funds in the account to reach at least the $2,500 maintenance margin level. The trader in this example will need to immediately wire $3,500 into his or her account or the brokerage firm will close the future position. In any event, the trader will need to deposit $1,000 to cover the loss that was in excess of the initial margin deposit.

From this discussion it should be clear that you should approach gold futures trading as a potential “high risk/high reward” endeavor.

2. Options on Gold Futures

In addition to being able to trade gold futures contracts via a futures trading account, a trader can also consider trading options on gold futures. Gold futures options are a “derivative” investment vehicle that trades based on the price action of the “underlying” security. In the case of options on gold futures, the underlying security is a futures contract for a particular expiration month.

There are two types of options: “call” options and “put” options.

The buyer of a call option pays an amount of money known as a “premium” to the option seller in order to acquire the right—but not the obligation—to buy the underlying security (in this case, a gold futures contract for a specific month) at a specified price (known as the “strike price”) up until a specified date known as the “option expiration” date. At the time of option expiration, a call option is worth the difference between the price of the underlying futures contract and the strike price of the call option. If the price of the futures contract is less than or equal to the strike price for the option, the call option has no value and will expire worthless.

Conversely, the buyer of a put option pays a premium to the option seller in order to acquire the right—but not the obligation—to sell the underlying security at the strike price up until the option expiration date. At the time of option expiration, a put option is worth the difference between the strike price of the put option minus the price of the underlying futures contract. If the price of the futures contract is greater than or equal to the strike price of the option, the put option has no value and will expire worthless.

In a nutshell, the buyer of a call option on a gold futures contract hopes that the price of gold will rise and the buyer of a put option on a gold futures contract hopes that the price of gold will decline. If the underlying gold futures contract does rise in price after you buy a call option on that contract, you may choose to either:

  1. “Exercise” the call option and purchase the underlying futures contract at the specified (presumably lower) strike price and then attempt to subsequently sell that futures contract at a price above the call option strike price, thereby generating a profit.
  2. Simply sell the call option if it has risen in price based on a rise in the price of the underlying gold futures contract.

Three Differences Between Gold Futures and Options on Gold Futures

There are many differences between options and futures contracts. For our purposes there are three key differences to note:

  1. Contract
    • A gold futures contract constitutes an agreement between a buyer and a seller to exchange cash for gold bullion on a specific date in the future at an agreed upon price.
    • An option on a gold futures contract gives the call (or put) option buyer the right to buy (or sell) a gold futures contract at the option’s strike price up until the option expiration date.
  2. Requirements
    • To enter into a futures contract, a trader must only put up a small portion of the actual value of the contract, referred to as “initial margin”.
    • To buy a call or put option, a trader must put up the full value of the option in cash at the time the trade is entered.
  3. Risk
    • A trader who buys (or sells short) a futures contract is at risk to lose more money than the initial margin that they put up in order to enter the trade.
    • A trader who buys a call (or put) option can lose no more than the amount of premium they paid to buy the option.

The primary advantage then to buying a call or put option on a gold futures contract is the peace of mind that comes with limited risk.

Example of Options on Gold Futures Contract

For our example, let’s assume that the December gold futures contract is trading at a price of $1,070.00 and that the initial margin requirement is $4,000. At $10 per each $0.10 tick, the contract value for this futures contract is $107,000.

At the same time, we will assume that the December 1070 strike price call option is trading at a quoted price of $8.00. At $10 per each $0.10 tick, the contract value for this option is $800.

Let’s assume that Trader A and Trader B both expect the price of gold to rise. Trader A chooses to buy a December gold futures contract while Trader B chooses to buy the December 1070 strike price call option.

  • Trader A buys one contract of December gold at a price of $1,070.00 and puts up $4,000 in margin money.
  • Trader B pays an option seller $800 and buys one December 1070 strike price call option at a price of $8.00.

 
Let’s take a look at two ways this could play out:

  1. The price of the futures contract rises

    By the time of option expiration, the price of the December futures contract has risen to $1,100.00. Trader A sells his futures contract at $1,100.00 and earns a profit of $3,000 [($1,100 - $1,070) X ($100 a point)]

    The December 1070 call option is worth the difference between the price of the futures contract ($1,100) and the strike price of the option ($1,070) or $30.00. So Trader B sells the call option he bought at a price of $8.00 at a price of $30 and generates a profit of $2,200 [($30.00 - $8.00) X ($100 a point)].

    In the end, Trader A made $3,000 on his $4,000 investment and Trader B made $2,200 on his $800 investment.
  2. The price of the futures contract falls

    By the time of option expiration, the price of the December futures contract has fallen to $1,050.00. Trader A sells his futures contract at $1,050.00 and suffers a loss of $2,000 [($1,050 - $1,070) X ($100 a point)]

    Because the futures price is below the call option strike price of $1070, the option expires worthless. As a result, Trader B suffers a loss of the full $800 he paid to buy the call option.

    Notice that if the futures contract had fallen further in price, then Trader A would have suffered additional losses while Trader B could not lose more than the $800 he paid to buy the 1070 call option, no matter how far the price of December gold futures may have fallen.

In general, buying a call or put option on a gold futures contract gives you the opportunity to participate in the price movement of gold without assuming all of the risks associated with trading futures contracts directly.

3. Exchange-Traded Funds (ETFs)

Prior to 2004, if you wanted to participate in the gold market your primary choices were mostly limited to buying physical gold bullion, trading gold futures contracts, or buying and selling shares of gold mining companies. However, with the advent of gold ETFs (exchange-traded funds), you can now participate in the movements of the price of gold just as easily as you can buy or sell shares of any stock.

There are several ETFs currently available that you can trade through a stock cash or margin account that are designed to track the price of gold bullion. There are several important advantages and disadvantages associated with buying gold ETFs versus other forms of gold investment.

Gold ETF Advantages

  1. You can participate in fluctuations in the price of gold just as easily as you buy and sell shares of stock.
  2. Unlike futures contracts or options, ETF shares do not have an expiration date. So you can hold the shares for as long or short of a time as you wish.
  3. You do not have to worry about transporting/storing/insuring your holdings as you would if you held physical gold yourself.
  4. You are not subject to the risks of leverage typically associated with trading gold futures contracts.

Gold ETF Disadvantages

  1. In a crisis, you do not personally own physical gold bullion and have no avenue to acquire it. In other words, you cannot contact the ETF’s sponsor and tell them to send you your share of the portfolio in gold bullion.
  2. You pay an annual expense fee to hold the ETF, which can serve to reduce returns over time.

Types of Gold ETFs

There are a number of gold ETFs available, each with distinct differences in several factors including what they hold, trading volume, and expense ratios. Here are just a few of the most popular gold ETFs:

  1. Spyder Gold Trust ETF (Ticker GLD)
    Shares of ticker GLD began trading on November 18th, 2004. Ticker GLD attempts to track the LBMA Gold Price PM Index divided by 10. So if the benchmark index stands at $1,000 per ounce, then one share of ticker GLD should trade for roughly $100 ($1,000 / 10). In order to purchase 100 shares of GLD at this price you would need $10,000 in cash, or to buy the shares on margin you would need to put up $5,000 in cash and borrow the other $5,000 from your broker.

    GLD holds 100% of its portfolio in gold bullion. As of late 2015, GLD was trading roughly 6 million shares per day and charged an annual expense ratio of 0.40%.4,5
  2. iShares Gold Trust (Ticker IAU)
    Shares of ticker IAU began trading on January 28th, 2005. Similar to GLD, it too tracks the LBMA Gold Price PM Index but divides it by 100, rather than 10.

    So if the benchmark index stands at $1,000 per ounce, then one share of ticker IAU should trade for roughly $10 ($1,000 / 100). To purchase 100 shares of IAU at this price you would need $1,000 in cash, or to buy the shares on margin you would need to put up $500 in cash and borrow the other $500 from your broker.

    IAU also holds 100% of its portfolio in gold bullion. As of late 2015, IAU was trading roughly 5 million shares per day and charged an annual expense ratio of 0.25%.4,6
  3. ETFS Physical Swiss Gold Shares (Ticker SGOL)
    SGOL is another popular gold ETF with a slightly unique twist. One concern some investors have with gold ETFs is that they don’t feel certain that their physically-backed gold ETF is storing their bullion securely and/or where exactly the vaults that hold the fund’s gold are located. For many gold ETF traders this is not an issue, as they are primarily interested in participating in the price fluctuations. However, for investors who have these concerns, charter ticker SGOL holds all of its gold in secure vaults in Zurich, Switzerland.

    Like IAU, SGOL tracks the LBMA Gold Price PM Index divided by 10.

    SGOL holds 100% of its portfolio in gold bullion in these vaults in Switzerland. As of late 2015 SGOL was trading roughly 30,000 shares per day and charged an annual expense ratio of 0.39%.4,7

Assessing Differences in Gold ETFs

  • What They Hold and Where
    Each of the gold ETFs listed hold 100% of their portfolio in gold bullion. GLD and IAU may hold their bullion in a variety of locations while SGOL holds all of its bullion in Switzerland.
  • Trading Volume
    For active traders, more trading volume typically—though not always—results in tighter bid/ask spreads and potentially better fills when entering and exiting trades. As of late 2015, GLD was consistently the most heavily traded gold ETF with IAU a fairly close second and SGOL a distant third.
  • Expense ratios
    Expense ratios are an important consideration for longer-term investors, more so than for shorter-term traders. A higher annual expense ratio eats up a larger amount of capital than a lower ratio. Because the ETFs we have mentioned all hold essentially the same thing—gold bullion—a lower expense ratio can serve as an advantage over longer periods of time.


As of late 2015, IAU had the lowest expense ratio of 0.25%, with SGOL second at 0.39% and GLD third at 0.40%. It should be noted that expense ratios can be raised or lowered over time. As a result, you may wish to verify the current expense ratio for any gold ETF you are considering prior to purchase.

4. Options on Gold ETFs

In addition to being able to trade gold ETFs, a trader can also consider trading options on gold ETFs. In the case of options on gold ETFs, the underlying security is the ETF itself.

Three Differences Between Gold ETFs and Options on Gold ETFs

There are many differences between ETF shares and options on those shares. For our purposes there are three key differences to note.

  1. Contract
    • Shares of a gold ETF represent partial ownership of the ETF’s portfolio holdings and have no expiration date. Gold ETF shares can be held for as long or as short a period of time as you decide.
    • An option on a gold ETF gives the call (or put) option buyer the right to buy (or sell) 100 shares of the underlying ETF at the strike price up until a specific date when the option expires.
  2. Requirements
    • To buy shares of a gold ETF, you either pay 100% of the cost of the shares from cash held in your stock trading account or you put up 50% of the cost and buy “on margin” (borrowing the other 50% from your stock brokerage firm). Buying ETF shares on margin involves paying interest on the money you borrow from your broker. There are also certain margin requirements that must be met, which simply means that if the total value of your account drops below a certain minimum level, your brokerage firm will require you to add money to your account.
    • To buy a call or put option, you must put up the full value of the option in cash at the time the trade is entered. Typically the cost of buying an option is less than the cost of buying 100 shares of the underlying gold ETF.
  3. Risk
    • A trader who buys gold ETF shares risks no more than the amount paid for the shares at the time they are purchased. A trader who sells short shares of a gold ETF can lose more than the amount put up to enter the position if the price rises significantly after the shares were initially sold short.
    • A trader who buys a call (or put) option can lose no more than the amount of premium they paid to buy the option.
The primary advantage to buying a call or put option on a gold ETF is that it typically allows you to control 100 shares of the ETF at a far lower cost than would be required to buy 100 shares of the ETF itself.

Example of Options on a Gold ETF

For our example, let’s assume that ticker GLD is trading at a price of $102 per share. At the same time the December 102 strike price call option is trading at a price of $2.00. Since each option is for 100 shares the cost to purchase one December 102 call option is $200 ($2.00 x 100 shares).

Let’s assume that Trader A and Trader B both expect the price of gold to rise. Trader A chooses to buy 100 shares of ticker GLD while Trader B chooses to buy the December 102 strike price call option.

  • Trader A buys 100 shares of ticker GLD at $102 a share and pays $10,200 ($102 x 100) to purchase the shares.
  • Trader B pays an option seller $200 and buys one December 102 strike price call option at a price of $2.00.


Let’s take a look at two ways this could play out:

  1. The price of gold rises
    By the time of option expiration, the price of ticker GLD has advanced to $110 a share. If Trader A sells his shares at $110 per share, he will earn a profit of $800 ([$110 - $102] X 100 shares).

    The December 102 call option is worth the difference between the price of GLD shares ($110) and the strike price of the option ($102) times 100 shares, or $800. So Trader B sells his call option at $8.00 and generates a profit of $600 ([$8.00 - $2.00] X 100 shares).

    In the end, Trader A made $800 on his $10,200 investment and Trader B made $600 on his $200 investment.
  2. The price of gold falls
    By the time of option expiration, the price of GLD has fallen to $97 per share. If Trader A sells his 100 shares at this point he will suffer a loss of $500 ([$97.00 - $102.00] X 100 shares).

    Because the ETF share price is below the call option strike price of $102, the 102 call option expires worthless. As a result, Trader B suffers a loss of the full $200 he paid to buy the call option.

    Notice that if the ETF share price had fallen further, Trader A would have suffered additional losses while Trader B could not lose more than the $200 he paid to buy the 102 call option, no matter how far the price of GLD shares may have fallen.

In general, buying a call or put option on a gold ETF can give you the opportunity to participate in the price movement of gold at a fraction of the cost of buying the ETF shares and also limits the amount of dollar risk.

5. Gold Mining Stocks and ETFs

The stock shares of companies that engage in the business of mining gold offer traders and investors another gold-related investment opportunity and trading alternative. Prior to the advent of gold ETFs that actually hold gold bullion in their portfolio, gold mining stocks were the most common choice for traders looking to make a play on the price of gold. Since that time, gold mining stocks have taken on the role of a more specialized—and generally more speculative—form of gold-related investment.

Gold stock prices have showed a historical tendency to be quite volatile. A trader who expects a rise in the price of gold may choose to purchase gold mining shares instead, hoping that the volatile nature of gold mining stocks will provide more “bang for the buck” i.e., that gold mining stocks will rise at a faster rate than the price of gold itself.

Certainly the price of gold is a key factor in valuing gold mining stock shares. However, while there is inarguably a strong correlation between the trend for the price of gold and the trend for the price of gold mining shares, there are other business-related factors that can cause gold mining shares to outperform or underperform gold bullion itself.

In addition to individual gold mining stocks, investors also have the choice of purchasing gold mining ETFs. These ETFs hold a portfolio of individual mining stocks designed to track a particular gold mining stock index. These gold mining ETFs offer investors and traders the potential to trade a basket of gold mining stocks via a single purchase, rather than having to choose individual issues.

Differences between Physical Gold and Gold Mining Stocks

The difference between physical gold and gold mining shares is pretty simple to spell out. Gold bullion is a piece of metal. A gold mining stock share is a piece of ownership in a company whose primary business is exploring for, mining and/or producing salable gold bullion. While a piece of gold bullion may sit in a vault or be worn as jewelry, a gold mining company must pay employees, buy equipment, and perform the actions required to extract gold bullion from the earth and bring it to market for sale.

As a result, gold mining stocks can be thought of as a derivative play on the price of gold. It should surprise no one to learn that the majority of gold mining stocks trade in a manner that is highly correlated to gold bullion. However, as it is in any line of business, not all gold mining stocks are created equal. Some companies run their business more efficiently than others and some have unique fundamental advantages over other companies in their industry. This is true of the gold mining industry just as it is for any other industry.

Individual Mining Stocks

Some investors will attempt to discern which individual gold mining stocks enjoy the best prospects for price growth and will focus their investment in those issues. The fundamental sales and earnings prospects for individual mining companies can change over time, so if you choose to invest in individual gold mining stocks, you should be prepared to do some homework to help you make decisions regarding which offers the greatest potential. A good place to start might be to consider a handful of gold miners who have been around a long time and typically enjoy greater trading volume. A short list of candidates for further research appears below. This list should be considered as a starting point as there are many more mining companies beyond the handful listed here.

Barrick Gold (ABX)
Goldcorp (GG)
Newmont Mining (NEM)
Kinross Gold (KGC)
Gold Fields Limited (GFI)
Agnico-Eagle Mines (AEM)

Gold Miner ETFs

If you are very good at picking individual stocks within an industry group, you may be able to maximize your returns by picking top-performing individual gold mining stocks. However, thanks to the advent of ETFs, it is possible to trade the gold mining industry as an asset class rather than having to pick individual stocks to buy. If you wish to hold a portion of your portfolio in gold mining stocks, there are several gold mining stock ETFs which allow you to buy a basket of gold mining stocks via a single purchase. Several of the more heavily traded gold miner ETFs are discussed below.

  1. Market Vectors Gold Miners ETF (Ticker GDX)

    Ticker GDX is an ETF designed to track the NYSE Arca Gold Miners Index. The ETF holds shares of roughly 40 mining stocks with over half of the portfolio value invested in the Top 10 holdings. The fund is primarily invested in large to medium size companies with almost 90% of the portfolio held in non-U.S. companies. As of late 2015, ticker GDX routinely traded over 50 million shares a day and had an annual expense ratio of 0.53%.7
  2. Market Vectors Junior Gold Miners ETF (Ticker GDXJ)

    Ticker GDXJ is an ETF designed to track the Market Vectors Junior Gold Miners Index. As the name implies, ticker GDXJ holds shares of gold mining companies with smaller market capitalizations than those held by ticker GDX. The ETF holds shares of roughly 60 mining stocks with about 40% of the portfolio value invested in the Top 10 holdings. The fund invests roughly 70+% in small to medium size companies with Canadian and Australian companies comprising roughly 80% of the portfolio. As of late 2015 the ETF routinely traded over 10 million shares a day and had an annual expense ratio of 0.57%.4,8

Other ETFs that track an index of gold mining stocks include iShares MSCI Global Gold Miners ETF (ticker RING), Gold Miners ETF (ticker SGDM) and Global Gold and Precious Metals Portfolio (ticker PSAU).

6. Options on Gold Mining Stocks and ETFs

In addition to being able to trade gold mining stocks and ETFs via a stock trading account, a trader can also consider trading options on those securities.

Three Differences Between Gold Mining Stocks/ETFs and Options on Them

There are many differences between mining and mining ETF shares and the options traded based on those shares. For our purposes there are three key differences to note.

  1. Contract
    • Shares of a gold mining company represent partial ownership of the mining company itself. Shares of a gold miner ETF represent partial ownership of the ETFs portfolio holdings. Stock and ETF shares have no expiration date. Gold mining stock and ETF shares can be held for as long or as short a period of time as you decide.
    • An option on a gold stock or gold miner ETF gives the call (or put) option buyer the right to buy (or sell) 100 shares of the underlying stock or ETF at the option’s strike price up until a specific date when the option expires.
  2. Requirements
    • To buy shares of a gold mining stock or ETF you either pay 100% of the cost of the shares from cash held in your stock trading account or you put up 50% of the cost and buy “on margin” (borrowing the other 50% from your stock brokerage firm). Buying mining stock or ETF shares on margin involves paying interest on the money you borrow from your broker. There are also certain margin requirements that must be meant, which simply means that if the total value of your account drops below a certain minimum level your brokerage firm will require you to add more money to your account.
    • To buy a call or put option, a trader must put up the full value of the option in cash at the time the trade is entered.
  3. Risk
    • A trader who buys gold mining stock or ETF shares risks no more than the amount paid for the shares at the time they are purchased. A trader who sells short shares of a gold mining stock or ETF can lose more than the amount put up to enter the position if the price rises significantly after the shares were initially sold short.
    • A trader who buys a call (or put) option can lose no more than the amount of premium they paid to buy the option.

The primary advantage to buying a call or put option on a gold mining stock or ETF is that it typically allows you to control 100 shares of the stock or ETF at a lower cost than would be required to buy 100 shares of the ETF itself.

Example of Options on Gold Miner ETFs

For our example, let’s assume that ticker GDX is trading at a price of $15 per share. At the same time, the December 15 strike price call option is trading at a price of $1.00. Since each option is for 100 shares, the cost to purchase one December 15 call option is $100 ($1.00 x 100 shares).

Let’s assume that Trader A and Trader B both expect the price of gold stocks to rise. Trader A chooses to buy 100 shares of ticker GDX while Trader B chooses to buy the December 15 strike price call option.

  • Trader A buys 100 shares of ticker GDX at $15 a share and pays $1,500 ($15 x 100) to purchase the shares.
  • Trader B pays an option seller $100 and buys one December 15 strike price call option at a price of $1.00.


Let’s take a look at two ways this could play out:

  1. The price of gold rises

    By the time of option expiration, the price of ticker GDX has climbed to $17 a share. If Trader A sells his shares at $17 per share he will earn a profit of $200 ($17 - $15 * 100 shares).

    The December 15 call option is worth the difference between the price of GDX shares ($17) and the strike price of the option ($15) times 100 shares, or $200. So Trader B sells his call option at $2.00 and generates a profit of $100 ($2.00 - $1.00 * 100 shares).

    In the end, Trader A made $200 on his $1,500 investment and Trader B made $100 on his $100 investment.
  2. The price of gold falls

    By the time of option expiration, the price of GDX has fallen to $12.50 per share. If Trader A sells his 100 shares at this point he will suffer a loss of -$250 ($12.50 - $15 * 100 shares).

    Because the ETF share price is below the call option strike price of $15, the 15 strike price call option expires worthless. As a result Trader B suffers a loss of the full $100 he paid to buy the call option.

Notice that if the ETF share price had fallen further then Trader A would have suffered additional losses while Trader B could not lose more than the $100 he paid to buy the 15 call option, no matter how far the price of GDX shares may have fallen.

In general, buying a call or put option on a gold mining stock or ETF can give you the opportunity to participate in the price movement of gold at a fraction of the cost of buying the shares and also limits the amount of dollar risk.

Conclusion

At this point it should be clear to you that there are many potential factors involved in deciding if, when, and how to invest in gold. This guide is intended to be comprehensive in terms of imparting the information you will need to decide if and when to invest in gold. It is also designed to help you to delineate between the relative advantages and disadvantages associated with each of the various gold-related investment vehicles available to you, including futures contracts, ETF shares, stock shares, and/or options on any of these.

In essence this guide is intended to help you formulate your own answers to each of the relevant questions associated with an investment in gold. Among the key questions that you may wish to answer before committing actual investment capital are:

  • Does an investment in gold appeal to you? And if so, can you put into your own words why it appeals to you?
  • What are the key factors that can influence the price of gold and how well do you understand them?
  • Are you interested in buying and holding gold or are you more interested in trading on a more active basis?
  • Do you have a preference in terms of the investment vehicle(s) that you will most likely use to invest in gold?
  • Do you wish to hold an interest related directly to physical gold bullion (gold futures, gold ETFs) or some related investment such as gold mining stocks or gold mining ETFs?


We encourage you to think through and generate answers for each of the questions posed above. By going through this process you can gain a greater understanding not only of the key factors involved in gold investing, but a greater insight into your own motivations, perspectives, and investment preferences and objectives.

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