Four Ways to Own Gold…tapping into a richer vein

Please consider three principles investors know for certain:

First, gold is money: a timeless, trusted, indestructible, portable, and universally recognized medium of exchange and store of value.

Second, they realize physical gold in moderation is an ideal component of a well-diversified portfolio; a powerful way to mitigate a wide range of impending risks that burden other asset classes and securities.

Third, they appreciate how gold operates in efficient, silent, and transparent world markets; an appealing safe haven to insulate real wealth from the vulnerability of paper gold in a world of fiat currencies.

The logic in support of ownership of gold is enhanced by its limited supply, coupled with its strong global demand for industrial, ornamental, and investment (portfolio diversification/store of value) purposes. The case for owning physical gold in investment portfolios is compelling and well-documented. But precisely how should the institutional investor, fiduciary or ultra-high net worth individual navigate the pathways to ownership? In this millennium, there have been four distinct ways to own gold, each avenue differing from the others in the degree of risk, cost, liquidity, and convenience. These methods of tying gold into a diversified portfolio differ in their degree of risk, return, immediacy of access to physical gold, and their independence from the banking system, among other important dimensions.

Pathway 1: Securitized Shares of Paper Gold

This first route to owning a claim to gold, at least indirectly, is to purchase ETFs 
(exchange traded funds) or securities on commodities exchanges. A typical share would have the value of one tenth of an ounce of gold. This method gives the investor title to a piece of paper that tracks the spot price of gold, while removing the need to pay the periodic fees for storage of physical bullion bars. One drawback of the most popular ETFs is that shares are redeemable only for a very few of the largest institutional customers.

This method of owning gold is popular among investors seeking a hedge or for short term trading requirements, but they must be aware of the expense ratios that accrue and the fact that they actually do not own the physical gold. As a rule, institutional investors do not buy gold ETFs as a matter of policy as they seek to minimize risk. The investor is limited in currencies in which they buy the security and the ETF is subject to counterparty risk. Examples: State Street/GLD or Blackrock/IAU.

Pathway 2: Future Gold

The second avenue to owning gold is the ETN (exchange traded note) that is based on the gold futures market. With higher risk and lower liquidity, these are essentially loans to banks that use the funds from investors over a period of time to pay a return contingent on the value of the underlying asset; in this case, the expected future price of gold. However, there is no principal protection. This provides the investor a way to play the futures market without buying contracts on the Comex, and the value can be volatile whenever substantial short selling buffets the market. With a heavy dose of speculation involved, returns can be large or losses can be total. Examples: gold certificates still issued in some countries, gold orientated funds and other collective investment vehicles, in addition to forwards and structured notes.

Pathway 3: Mined Gold or “Miners”

The third major route to ownership of gold is buying shares in the actual gold mines. These publicly-listed equities are referred to as “miners”. Because only a small proportion of mines do indeed strike gold in commercially viable amounts, this way of owning gold is the riskiest of all. Miners are apt to be heavily leveraged, whether upside or downside, to the spot price of gold. Costs of mining and refining have been rising, and complex labor issues have eroded profit margins and curtailed production levels. Even during the long bull market for gold from 2001-2012, exploration remained risky, takeovers were common, failed enterprises were frequent, and stock values gyrated unreliably. The oldest and largest producers have not been immune. Like any stock in a high-risk industry, miners are very low in liquidity and unpredictable in rates of return. The average value of even the most successful miners has been known to fluctuate 30% upwards and/or downwards during the course of a year, so the investor is well-advised to diversify within their types of gold holdings.

Pathway 4: Physical Gold Vaulted in the Owner’s Name and Deliverable

The fourth approach is the direct ownership of physical gold or bullion in the form of jewelry, coins, and bars. This method is especially popular in India and China where half of the gold in the world is stored in vaults, safe deposit boxes, or hidden “under the pillow” in homes. Bought online or from coin dealers and jewelers, this method of ownership is sometimes accompanied by substantial price premiums, as well as uncertainty about the intrinsic value of gold creations such as rare coins and ornate objects from a dealer. In this approach to gold ownership, the physical metal can be stored safely in a vault owned and managed by a depository. Good examples of enablers of this option to store standardized bars and coins are Bullion Vault and Gold Bullion International, in addition to closed-end funds such as Sprott Asset Management, although redemption is difficult and gold funds are much closer to securities than they are to physical allocations.

Superior to the illiquidity of jewelry, the most flexible and desirable way to invest in direct ownership of physical gold, with each unit of the asset highly liquid, is to buy and individually own clearly coded and transferable units of standardized gold bullion, numbered and marked like a security. In this approach, there exist no prohibitive mark-ups, exorbitant premiums, or barriers to liquidity. The gold is solidly insured, regularly audited, fully allocated, physically segregated, unambiguously titled, totally secure, and smoothly deliverable. And highest standards of liquidity prevail without question, as “good delivery” gold is continually verified in the process. This option is the epitome of physical gold ownership, for while it maintains inviolable safety, it also provides a needed separation between the investor’s gold and the unpredictability of the global banking system. It employs advanced messaging and an accessible system to facilitate the ownership of precious metals. Because gold is the oldest and most trusted form of money, this tangible pathway to gold ownership facilitates bullion allocations that are essential for managing risk, maintaining a universal store of value, and serving as a medium of exchange.

For the institutional marketplace, positions taken in physical gold are completely allocated and segregated, enabling accessible redemption. The process does for the gold market what SWIFT did for cash management in the nineteen-seventies. The modernization of physical precious metals as an asset class has begun.

Roy Van Til, Ph.D.

Vienna, ME USA

royvantil@mac.com

207-500-9604