5 things to consider when investing in gold
When people talk about gold, the imagery of stacks of gold bars in a safe pops up in mind. But is that the only way you can buy gold?
There are two ways to invest in gold – you either get physical gold or buy paper gold.
If you get physical gold, you will need to think of how you would keep your gold bars and coins safe. For starters, you probably need to get a safe to store your metals and perhaps even consider installing a security system. This is why many investors turn to paper gold.
What is paper gold
The term 'paper gold' refers to an asset that reflects the value of gold, so it is considered to be 'on paper' and the investor doesn’t keep the physical gold itself.
What you need to consider before including Gold into your portfolio
Most investors buy into gold whenever financial markets are unstable, like when there is geopolitical turmoil.
Considered a safe-haven asset when markets are volatile, gold is an asset that is influenced by various factors, not just by investment demand. This makes it effective to help diversify and balance out other losses in times of market stress.
Gold generally retains its value so it is a fall-back asset in uncertain times. But on the other hand, when markets are stable and rising, investors go for other assets that can give high interest for greater returns.
We look back at history to illustrate this:
Gold prices soared between 2007 and 2011 because of the following events:
- A financial crisis triggered by defaults on US subprime mortgage debt (when homeowners with poor credit histories defaulted on their loans)
- The subsequent collapse of US investment bank Lehman Brothers.
- Compounded Euro Area Debt crisis (over concerns that a few European countries, especially Greece, had borrowed beyond their means)
Psychologically, these events drove demand for gold.
If you had bought gold at the start of the Global Financial Crisis in 2007, it would have cost you about US$600 per ounce; and by 2011, gold had hit a high of US$1,900 per ounce.
At the end of 2019, spot gold was around US$1,509 per ounce.
Investors also buy gold as a hedge – to use gold as a safeguard against portfolio losses. This can be a strategy to manage risk, as gold can balance out losses for other assets.
In other words, investors are more inclined to invest in gold when currencies fluctuate.
For example, many investors buy gold to hedge against a scenario when major currencies (eg. US dollar or Euro) weaken as:
- Currency strength is affected by how much money is in circulation.
Known as money supply, this refers to the total amount of money that is available in an economy at a specific point in time.
- Money supply is decided by central banks.
- When there is an increase in money supply, the currency weakens.
In contrast, gold supply is independent and is not controlled by central banks.
When interest rates are near-zero or negative, investors find more reasons to invest in gold rather than keeping money in the bank.
Let’s use the situation in Japan and in some European countries in May 2020, using the Euros to explain why.
In these countries, interest rates are negative. This means that if you have a bank account there, you pay the bank interest to safekeep your savings with them, which is the exact opposite from the experience in Singapore, where banks pay us interest on our deposits.
So, if you own gold instead of cash savings or deposits, you will not need to pay out any interest when interest rates are zero or negative.
However, the opposite is true when interest rates are positive. You won’t earn any interest on gold, whereas you can enjoy earning interest on your savings in the bank.
Having different investments that are not closely correlated to one another can help to diversify your investments, so you “don’t put all your eggs in one basket”.
Gold usually has a negative correlation to other assets like stocks and bonds so investors often add gold in their portfolios to balance out market fluctuations and risks.
On the other hand, unlike dividend stocks like bonds and property rentals which generate interest when markets are good, gold does not earn profits or yield interest.
One of the ways to invest in gold is through Gold Linked Notes (GLNs), which can be a good investment if you expect gold prices to be stable or to increase.
GLNs are also relatively short term investments and can be tailored to your risk appetite in discussion with your banker or broker.
If you expect gold prices to rise sharply, you can consider buying another type of paper gold – spot gold, which can be bought or sold at the current market price at any point in time.
Still, you need to be mindful that gold prices can move quickly. While gold is a steady, safe-haven asset, its prices can still fluctuate.
In addition, gold is typically reflected in US dollars, meaning you will have to consider foreign exchange fluctuations against the Singapore dollar.
How GLNs work
GLNs are like contracts signed between an investor and a banker (or issuer). Before investing in a GLN, both parties agree on the conditions such as the timeframe and the strike price, which is the agreed price to exercise the deal.
If the price of gold stays above the strike price within the agreed time frame, as stated in the terms of the GLN, you will get back your principal with the agreed yield.
But if the note falls below the strike price after the agreed timespan, you will receive spot gold – which is gold at the current market price – in return. This spot gold will be credited to your “Gold Account”, and you can buy and sell it through your Relationship Manager.
Read more about Gold Linked Notes
As you think over the pros and cons of investing in gold, you can also speak with your relationship manager to find out if gold would fit into your portfolio.
Disclaimers and Important Notice
This article is for information only and should not be relied upon as financial advice. Any views, opinions or recommendation expressed in this article does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability. This article is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.