Pros And Cons Of Investing In Physical Gold

| May 10, 2022

Is Gold a Good Investment? Learn the Advantages and Disadvantages of Investing in Gold

Physical Gold

With inflation at higher levels than we’ve seen in decades, investors are wondering if investing in gold is a good investment. This article will answer all of your questions related to investing in physical gold, gold coins, gold ETFs, and gold mining companies. You’ll learn whether gold is a good inflation hedge, if gold coins are a good investment, which is better physical gold or stocks, and finally the pros and cons of investing in physical gold. You’ll also find out ways to invest in gold.

The End of the Gold Standard

Gold’s importance changed in the U.S. in 1971, when President Nixon ceased the convertibility of gold into U.S. dollars, thereby ending the gold standard. The decoupling of the dollar with gold, took the brakes off gold’s inherent way to control inflation. Following the halting of gold standard, gold prices soared during the 1970’s and 80’s and then traded flat for the next 20 years. 

Although gold has not been a perfect inflation hedge, and has lower annual returns than the stock market, its diversification benefits are sound and could support the validity of adding a gold allocation to a diversified portfolio. 

What is Gold Investing?

Gold has been considered a valuable commodity for thousands of years, and is likely to continue its allure. Investing in gold is simply buying and selling  gold. You could buy physical gold with an app, or purchase gold through exchange-traded funds or gold mining company stocks.

Gold can provide diversification in a stock and bond portfolio. Today, gold investing is similar to commodity investing, which means that investors should expect the same sort of volatility or price fluctuations that accompany owning commodities. If you are investing in gold, you should be prepared to see large changes in your investment value.

The best reason to consider gold as an investment – not as a speculative holding or trading vehicle – lies in gold’s perceived value. That is, gold is a storage of value due to pretty much everyone – both people and governments – agreeing that gold is a valuable commodity. This is why gold can appreciate in value despite it not offering a yield or dividend.

Opinions abound concerning whether to invest in gold, or not.  

Pros of Investing in Gold

  • Diversification
  • Store of value
  • Historic trustworthiness; likely to be considered valuable in the far future
  • Lower correlation with the broader investment markets

Cons of Investing in Gold

  • Offers no yield or dividends
  • Has storage cost (for physical gold)
  • Lower historical performance in contrast with other assets
  • Returns barely beat inflation

How to Invest in Gold?

Gold investing has been around for centuries. Today, there are a preponderance of methods for investing in gold. You could buy the actual metal in the form of bars or coins, buy stock in gold-mining companies or invest via other market derivatives like gold futures.

Ways to Invest in Gold

You can buy physical gold through a gold app like Vaulted. They will store the gold for you, or you can take possession of the physical gold. You’ll also find many dealers, individuals or online platforms that sell gold.

Gold coins are available at the US Mint or a dealer.

You can buy a gold fund. The SPDR Gold Shares (GLD) ETF is a low cost efficient way to access the gold market. Other gold funds include Invesco DB Gold Fund (DGL) and the Franklin Gold and Precious Metals Fund (FKRCX). The Sprott Physical Gold Trust (PHYS) is a closed end gold fund where unitholders have the ability to redeem their units for physical gold.

An alternative to physical bold is to buy a publicly traded gold mining company or fund. You can buy an ETF like VanEck Gold Miners ETF (GDX) which strives to match the price and yield of the NYSE Arca Gold Miners Index (GDMNTR). Individual gold mining stocks include Barrick Gold (GOLD), Newmont Mining Corporation  (NMC),  Sibanye-Stillwater Ltd. (SBSW) and Equinox Gold Corp. (EQX).

Advanced investors might buy gold futures. In general, futures trading, is best left to sophisticated traders. It is a contract between a buyer and seller where the investor agrees to purchase gold from the seller at a pre determined future price. It’s best to learn more about futures trading before embarking on this method of buying gold. 

Are Gold Coins a Good Investment?

While it might be tempting to go the easy route of acquiring physical gold, such as via jewelry. For investment purposes other methods of gold are preferable. For a physical gold to be fully valued, it must be certified, and gold coins issued by a government mint are certified. If you are holding non-certified gold and wish to sell it for full value, you’ll need to get it certified, often at a cost that could eat into your profits. Gold coins circumvent this problem.

Gold investors should be aware of the percent of gold within the bar or coin as well. The higher the percentage of gold, the better.

When considering the investment returns of gold, there are better investments such as stocks and REITs. There have been periods of time when gold has been a very good investment, and other epochs when gold’s price has declined or been flat. The average annual return of gold since 1982 has been about 1.59% annualized. Although the 1970’s and the first decade of 2000 saw robust growth in the price of gold.

Yet, those looking to maximize their gold investing and find a vehicle to track the price of gold might lean towards gold bars, over gold coins. Coins can be beautiful and fun to own, yet they typically contain a lower percentage of gold than comparable weight gold bars.

On the flip side, coins are smaller than bars, so you don’t need as much capital to buy them. This allows for easier dollar cost averaging, and so you could – for example – build your gold investment by buying a coin per month without much overhead. In addition, coins made by different mints are considered collector items and can become more valuable than the actual gold within the coin, due to scarcity or demand.

After you start collecting gold coins, you might find that your investment becomes your hobby. Unlike most hobbies, gold coin collecting comes with potential profit instead of cost.   

If you’re seeking to buy a higher concentration of gold, then buying gold bars is better than investing in gold coins. And if you don’t have the money to buy a complete bar of gold, you can buy a small amount of gold with an app.

Inflation Rate from 1960 to 2022


Is Gold a Good Inflation Hedge?  

With inflation inching upwards, investors are turning to gold investing. Gold is often considered to be a hedge against inflation. The CPI or US consumer price index is used as a barometer of inflation and the relationship between the CPI and gold prices is weak-ish. 

Since 1971, only 16% of the changes in gold prices are explained by changes in the inflation rate. In the chart below, the purple dots show the periods of a strong relationship between gold returns and high inflation. 

Gold vs Inflation 1971-2020


Although gold has appreciated during certain periods, many of which aren’t correlated with increased inflation, there is little data to suggest that inflation consistently drives gold prices.

A weak correlation doesn’t imply no correlation between gold prices and inflation. Yet, there may be better inflation hedges than gold. A study by Bloomberg, World Gold Council from 1998 to December 2020, found that real estate and the 10 year TIPs were more consistent hedges against inflation with gold clocking in at third place. 

Adjusted for inflation, gold returned roughly 1.594% between 1982 and 2022. When you take into account transaction costs, that annualized return will decline. In short, when considering data from the last 40 years gold might be considered an inflation hedge, but certainly not the best for capital growth.

Next, consider stock vs gold vs intermediate US treasury returns form 1971 to 2021. You’ll notice a big difference in gold’s return when the 1970’s are added to the calculation.

Stocks vs Gold vs Treasuries Returns – 1971 to 2021


Should I Buy Physical Gold or Stocks?

Physical gold should be seen as a safety net – a preservation of value – more so than an outright investment. Most stocks, in contrast, are investments. When comparing growth of the S&P 500 with that of gold prices, the stock market prevails. 

The S&P 500 returned 11.2% annually since August 1971, with dividends reinvested. In contrast, gold delivered an 8.2% annualized return. That gold performance drops to 1.594% if we remove the high returns from 1971 to 1982.

As for buying physical gold or gold stocks, keep in mind that physical gold often sells at a premium. That makes gold stocks a cheaper option. In addition, buying and selling gold stocks or funds is an easier and faster process than is buying and storing physical gold.

If your time horizon is short – i.e., you want to invest in gold for under a decade – you are likely to find funds or even future contracts more convenient than beginning a gold coin/bar collection. In the end, though, no one says you cannot do both. You can hold physical gold for worst-case scenarios, own a gold ETF in your portfolio for diversification, and buy gold stocks for investment.

For long term investors, seeking capital appreciation, the stock market has delivered greater returns than gold investing.  

Does Gold Lose Value?

Gold’s value is influenced by supply, demand and investor sentiment. Gold is a shiny valuable metal and has been considered important for a long time. Likely, gold will only lose value if investors lose faith in the metal, a phenomenon that is unlikely to occur anytime soon.

If you were to value gold objectively, such as via its use in electrical and jewelry manufacturing, the metal is highly overpriced. This keeps value investors, such as Warren Buffett, away from gold. But this does not mean gold is losing value over time.

Rather, gold’s benefit lies in its so-called “store of value.” It is not only a faith-based commodity with a long track record, but it is rare. It cannot be artificially manufactured, and it does not decay over time. If you buy a gold coin now, you will have the same amount of gold relative to the total amount of gold in circulation decades from today, as there is a finite supply of gold. 

That said, the price of gold can go up and down, and there have been long periods of time, like 1980 to 2000 and 2010 to 2020, when gold’s price has remained flat.

Is There a Downside to Investing in Gold?

Gold has a real expected return of zero. Over a long enough time horizon, gold holds its value against inflation, meaning that – on average – the performance of gold relative to nearly any asset, whether it be one with yield or equities, is poor. Gold is often bought as a hedge against inflation, despite the reality that the price of gold is inconsistently impacted by inflation.

Moreover, gold comes with extra expenses. Physical gold sells at a premium and often requires storage costs. Gold is also taxed as a collectable, which is the same as your marginal income tax rate and capped at 28%. And even gold fund purchases are taxed unfavorably.

Lastly, gold is volatile. Investors should be rewarded for holding risky, volatile assets, as is the case for stock investing. However, gold doesn’t reward investors for its commensurate risk and the risk/reward profile for investing in gold is poor in contrast with investing in stocks.

That said, adding a small gold allocation to an all stock and bond portfolio might temper the volatility of returns.

Gold vs Cryptocurrency Investing – Which is Better? 

Digital currency, spearheaded by the founding of Bitcoin in 2009 is emerging not only as a currency, but also as an investment. The future of cryptocurrency investing is less certain than gold, which has been around for thousands of years. As businesses, and even governments begin to accept digital currency, there’s a possibility that some gold enthusiasts will transition to cryptocurrency investing. 

Whether gold or cryptocurrency investing is better depends upon your investment objectives and risk tolerance. In 2009, one bitcoin was worth $0.09. Bitcoin reached a peak of $68,990 in November 2021 and on May 5, 2022 one bitcoin is trading at $35,803. Gold closed out 2009 at a price of $1104, and is trading today at $1881. Clearly, bitcoin has had a better run than bitcoin cryptocurrency since 2009.

Investors seeking the potential returns that surpass the S&P 500, crypto might be a better alternative. If you want a secure store of value, with a long history, then consider gold investing. 

Investing in Physical Gold Wrap up

Physical gold is a highly concentrated store of wealth. The benefit of gold investing comes from it’s long history as a valuable commodity. Gold also has validity as a portfolio diversifier. Small allocations to gold can smooth out the volatility of a diversified portfolio.

But, gold comes with its own problems, including storage risks (getting lost or stolen), counterfeiting (usually via tungsten) and extra costs (certification, taxes, and premium prices). You can alleviate many of these problems via an online vendor such as Vault. Gold isn’t the best asset for capital growth and tends to underperform over time

Ultimately, gold is a reasonable alternative for diversifying your portfolio and adding a small ballast against inflation. As always, perform your due diligence before investing.

This article originally appeared at Barbara Friedberg Personal Finance.

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Category: Commodities

About the Author ()

Damon is a regular contributor to Investors Alley. He believes understanding both the stock market and each individual stock as a sort of random process with its own characteristics allows us to more accurately predict what it will do in the future. Coupling statistics with fundamental analysis, he has the goal of revealing to you the hidden patterns within stocks so that you may do what you wish with that information.

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