Gold as an asset class
As an asset class, gold is unique. The economic forces that determine the price of gold are different from the economic forces that determine the price of many other asset classes such as equities, bonds or property. For example, the supply and demand of gold is impacted by the global supply and demand for both gold jewelry and certain electronics and medical equipment that are manufactured using gold.
Similarly, because gold is a currency, its price does not behave like other commodities and the performance of gold mining companies (known as gold equities) do not behave like other mining companies.
This means an investment in gold bullion or gold equities offers important portfolio diversification. In addition, because gold is a currency and holds intrinsic value, it can provide protection during periods of inflation.
Why investors choose gold
Gold has been used to store and grow wealth for centuries. Gold gave rise to the concept of currency and its popularity continues among investors today with gold being one of the most traded asset classes in the world. Investors favour gold because:
Gold holds intrinsic value
Gold has intrinsic value due to its unique characteristics. Its rarity, malleability, conductivity and durability give rise to its many uses, including jewelry, as decoration, in electronics and medical applications.
Gold is considered a “safe haven” in times of market turmoil
Investors often turn to gold in periods of uncertainty. According to the World Gold Council, “as a crisis hedge, gold has a solid history, driven by its lack of credit risk and negative correlation to risk assets.”
It’s been used as a hedge for both deflationary and inflationary environments
In a deflationary environment, where asset values are falling sharply, gold has shown to maintain its value. It is typically a similar scenario for gold in inflationary environments when purchasing power is being rapidly eroded by rising prices and devalued currencies.
Gold carries no liabilities and no counterparty risk
Unlike owning bonds or shares in a company, an investment in gold bullion is not beholden to the quality of a management team nor is its value derived from the likelihood of corporate failure.
When confidence erodes in the world’s reserve currencies, investors often turn to gold.
The price of gold is generally inversely related to the strength of the world’s reserve currency - the US dollar - because its value is expressed in US dollars. All else being equal, a rising US dollar would equate to a falling gold price, while a falling US dollar is likely to drive the price of gold higher through increasing demand as more gold can be purchased when the dollar is weaker.
For this reason, gold is often used as a hedge against inflation. As prices rise, the value of currency falls. So as inflation rises, so too does the price of gold.
How to start investing in gold
There are three ways investors can gain exposure to gold:
Buying physical gold
Investors can purchase gold in the form of jewelry or coins. However, you will likely pay an excess over the gold price due to the craftmanship involved in creating the piece of jewelry or coin. Investors can also purchase physical gold in the form of gold bars by visiting a gold dealer. However, physical gold also attracts an additional fee in the form of fabrication costs associated with creating the bars, and there are additional challenges in the form of storage and the added cost of insurance.
Investing in gold ETFs
There are many types of gold funds on offer that provide investors with exposure to the price of gold. The way these types of funds operate varies significantly, with the most popular being gold exchange traded funds (ETFs). Gold ETFs offer investors all the benefits of ETFs, being transparent, easily accessible on an exchange like the ASX, highly liquid and typically low cost.
There are a number of gold ETFs listed in Australia and each takes a different approach with regard to how it provides investors exposure to the price of gold. When selecting a gold ETF, it is important to understand its structure and any increased risks that structure may incur for the investor.
Some gold ETFs have deferred purchase agreements, with a third party holding the gold, which exposes the investor to credit risk. Other gold ETFs have a company structure which removes protections from a normal fund structure. Some gold ETFs buy units in another gold ETF listed somewhere else in the world. There are also some gold ETFs which hold Russian gold.
There is only one gold ETF on ASX which avoids these issues and only invests in Australian-sourced gold. Explore the VanEck Gold Bullion ETF (ASX: NUGG), which tracks the price of gold and allows investors to redeem their ETF units for physical gold held at The Perth Mint.
Investing in gold mining companies
Investors can also gain exposure to the price of gold by investing in listed gold mining companies. Purchasing shares in these gold companies offers investors similar benefits to investing in gold, with the added advantage of also providing potential income in the form of dividends.
The world’s largest gold mining ETF is listed on NYSE and traded around AU$1 billion a day in 2023. The VanEck Gold Miners ETF (GDX) invests in the world’s largest gold miners and is also available on the ASX.