The Best Strategy for Gold Investors

The pursuit of gold has led to murder and mayhem, wars, and an unrelenting fascination for much of history. Gold is so important that it has become synonymous with the word "wealth." But having gold nuggets, coins, or futures contracts does not mean your portfolio value is rising, or that it's safe. Let's explore gold futures, as well as usage in an investment portfolio.

Somewhere Over the Horizon

Most of the gold supplied to the market each year goes into manufactured products, with the remainder going to private investors and monetary reserves. Gold has a long history of use as currency or as a reserve backing for other forms of money. However, the gold standard is not currently used by any government, having been replaced completely by fiat currency.

Investing in the financial markets demands the ability to change perspectives over time. If gold bars or Krugerrands (a one-ounce South African gold coin) are purchased, then the physical possession of that gold remains the same regardless of the market price. Investment is a choice to risk capital with the hope of gain. Yet ownership is for the sake of ownership, regardless of any gain in price.

Diversification of a portfolio means varying the asset classes. Stocks are one asset class. Gold is another. Owning a company's stock means owning an equity stake in a company. The value goes up or down, changes with the market, and the paper certificates can be worth nothing. The value of gold goes up and down and changes with the market but is never worth nothing. Therein lays the major difference. You may not profit from owning gold, but at least you will own a desirable tangible asset, whatever the monetary value.

Portfolio planning also takes into consideration intent. Is the intent to increase wealth or to have gold, which can at any time be traded for food or shelter? Both goals can be accomplished with knowledge of the markets. Gold held for an emergency is different than buying a futures contract or stock in a gold mining company. Holding gold against an emergency does not necessarily increase wealth. Gold can be part of one's wealth, but it can decrease in value too.

Let's compare buying gold Krugerrands to buying another physical asset, such as a home. Whether the price of the home goes up or down, you still have a home to live in and it is part of your estate. Whether the price of gold Krugerrands goes up or down, you still hold them and they are part of your estate. Now let's look at buying shares of an exchange-traded fund (ETF) like the SPDR Gold Shares GLD (NYSE: GLD) (Figure 2). If the price goes down from where you buy it, you have lost money and the paper may even become worthless if market selling action greatly overshadows buying action. That said, ETFs are backed by tangible gold reserves, but the ETF share values are sensitive to technical (supply vs. demand) dislocations.

Gold Futures

There are two ways to invest in the gold market, either buying the physical commodity gold or buying a futures contract. Buying the physical commodity gold is to have ownership. Thus, although the price will fluctuate, ownership is final. Buying a futures contract or stock is speculation, where you do not own any gold but can make a profit.

A gold futures contract is a legally binding agreement for the delivery of gold in the future at an agreed-upon price. The contracts are standardized by a futures exchange as to the quantity, quality, time, and place of delivery. Only the price is variable. The contract refers to the commodity "gold." Gold stocks are not a commodity in this sense. Stocks of gold miners or related companies offer shares, but this does not represent any form of gold ownership.

Gold bullion is any type of gold product that is sold for the gold content. The price of gold bullion, in whatever form, follows the daily spot price of gold. The gold bullion market is international. The demand is global. Gold is being traded somewhere in the world at virtually every hour of the day.

The Golden Commodity

The phrase "flight to quality" usually refers to gold, which is often called the currency of last resort. The premise is that if there is an economic collapse and paper money becomes obsolete, gold will retain value. Currency is any form of money of any country, and money is anything that can be exchanged or bartered for something else, making gold the ultimate form of money during an economic recession.

If the desire is to have a commodity as an alternative medium of exchange, buy gold bullion. Foreign currencies do not replace gold because no country is on the gold standard. A purchase may require more or less gold, depending on demand, but gold is usually acceptable.

Gold stocks are not redeemed for gold. Gold futures contracts are seldom redeemed for gold. Buying into a gold fund or index does not mean you have possession of the commodity gold. Buying foreign currencies is not a substitute for the commodity gold.

Ownership of gold is accomplished only by purchasing gold bullion. Gold bullion is any type of gold product that is sold for the gold content. It can be gold coins, gold bars, or gold jewelry.

Trading Gold and Inflation

Money and gold may seem the same, and they can all be an equally acceptable currency, but they are different. Money is anything accepted as payment. Currency is often country-specific and is represented by paper notes issued by the government. It is money but it is not gold. Gold (as well as silver) is money and a medium of exchange. Gold can be a currency, but it is also more than that, as it is a tangible asset and the only investment not monetized by debt.

Gold and Currencies

The foreign exchange market (forex or FX) refers to the market for currencies. The foreign exchange market does not imply any representation of gold. It is plainly one country's currency against another. Fiat money is redeemable for nothing, while gold always retains its monetary status.

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