How to invest in gold

·8-min read
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Given current stock market volatility, investors may be looking at alternative asset classes to diversify their portfolio. Gold could be one such asset, being seen as a safe haven during times of economic turbulence as well as a hedge against high inflation.

We’re going to take a closer look at investing in gold, including the benefits of adding gold to your portfolio, and the different investment options available.

How is the price of gold determined?

There’s a finite supply of gold, with the volume of gold mined to date measuring only 21 cubic metres, according to the World Gold Council (WGC). As a result, the price of gold is highly sensitive to fluctuations in demand.

Figure 1 shows how the spot price of gold (per ounce) has changed over the last 30 years. The price of gold has risen more than seven-fold over this period, from less than £200 in 1992 to its current price of over £1,440 (as at August 2022).

The gold price is set in the UK by the London Bullion Market Association (LBMA). The fixed price is set twice-daily when LBMA members meet to agree a price that matches buyers with sellers, typically used for larger orders. The spot price is a ‘live’ price, used mainly for buying and selling gold bullion.

The G7 countries recently announced a ban on future imports of Russian gold, as part of the package of economic sanctions against Russia. This does not apply to gold bought legitimately from Russia before the ban was imposed.

Why invest in gold?

Investors might consider investing in gold for the following reasons:

1. Preservation of wealth

Inflation erodes the ‘real’ value of money over time or, put another way, £100 today buys you less than it did 50 years ago. Gold is a real physical asset that holds its value, whereas inflation reduces the value of ‘fiat’ currencies such as the British pound or US dollar.

Investing in gold can therefore help to protect the ‘real’ value of your wealth against inflation. As a result, investors often revert to holding gold in times of high inflation, and this increased demand pushes up the price of gold.

Annual inflation has averaged 3% in the UK over the last 20 years compared to a 10% increase in the price of gold, according to the WGC. Therefore, the ‘real’ value of gold has increased by 7% per year on average, compared to a 3% decrease in the ‘real’ value of the pound.

2. A safe haven

The value of a currency is impacted by economic policies on interest rates and the supply of money, however, the value of gold is a function of supply and demand. Due to this, gold tends to be a popular ‘safe haven’ when there is geopolitical and economic volatility.

The WGC reported that global demand for gold increased by 34% in the first three months of 2022, principally due to the war in Ukraine. It commented that this period was “a turbulent one, marked by geopolitical crises, supply chain difficulties and surging inflation.” The WGC added that “global events and market conditions have solidified gold’s status as a safe haven holding.”

3. Diversification across different assets

In addition to cash, shares, property and bonds, gold can help to diversify investment portfolios across a variety of different assets. Diversification helps to protect against one type of asset, such as shares, underperforming.

Gold is often described as being ‘inversely correlated’ to other asset classes. As a result, if stock markets fall due to high inflation and economic concerns, gold may produce superior returns.

What are the disadvantages of investing in gold?

As with most asset classes, investing in gold carries a level of risk as its price can be volatile. This can cause a potential issue if investors are looking to sell gold at a time of depressed prices. In addition, gold does not produce an income for investors, unlike savings, bonds and shares paying dividends.

Buying and holding gold in physical form can also be difficult. Investors need to ensure the authenticity of the gold, store it securely and find a buyer once they are ready to sell their gold.

How can you invest in gold?

You can invest in gold by buying it in physical form, or indirectly, through a gold-based investment product.

1. Buying gold directly

The value of gold is determined by its carat, with higher-carat gold containing a higher proportion of gold relative to other metals. The highest carat is 24, which is pure gold.

There are three main forms of physical gold, available from The Royal Mint (the official mint in the UK) and metal dealers:

  • Gold coins: the flagship coins offered by The Royal Mint are the Britannia and Sovereign. The one ounce 999.9 fine gold Sovereign coin would currently cost £1,500, whereas a quarter-ounce Britannia coin would set you back £400. As legal tender, UK residents are not required to pay VAT or capital gains tax on Britannia or Sovereign coins.

  • Bullion bars: most people probably think of bullion bars in bank vaults when they think of buying gold. Bars vary in weight from one gram to over 10 kilograms. Bullion bars are stamped with the weight and purity level. The Royal Mint is currently charging just under  £49,000 for a 999.9 fine gold one kilogram bullion bar.

  • Gold jewellery: you will typically pay a mark-up of at least 20% (relative to the value of the gold)  when buying gold jewellery. This covers the labour and cost involved in designing and making the jewellery. You can calculate the size of this mark-up by looking up the spot price of gold, provided you know the weight and carat of the jewellery.

Whether you’re looking to buy coins, bullion or jewellery, it’s important to find a reputable dealer, or buy gold directly from The Royal Mint. Members of the British Numismatic Trade Association are required to adhere to a code of ethics for trading in metals.

You should also bear in mind the cost of insurance, along with fees if you store your gold in a third party’s vault or safety deposit box. The Royal Mint charges customers 1% (plus VAT) per year, based on the value of the gold stored in its vaults.

2. Buying exchange-traded products

Exchange-traded funds (ETFs) and exchange-traded commodities (ETCs) are a simple and low cost way of investing in gold, as well as other commodities. Some hold the gold in physical form, or via futures contracts, while others replicate a broader index such as precious metals.

Investing in ETFs is a low-cost way of tracking gold or broader commodities, charging annual fees of around 0.1-0.2% compared to 0.5%-1.0% for actively-managed funds.

By way of example, the iShares Gold Bullion ETF and Invesco Physical Gold ETC have both achieved 5-year total returns of around 50%, according to data from Trustnet.

3. Buying gold funds

Gold funds generally invest in mining companies, rather than the underlying gold itself. If the price of gold rises, this has a positive impact on the revenue of mining companies.

Examples of gold-based funds include the LF Ruffer Gold and 63% Ninety One Global Gold funds which have achieved five-year returns of 63% and 39% respectively, according to Trustnet.

4. Buying shares in gold mining companies

Another option is to buy shares in companies that mine, refine and trade gold as the share prices of these companies are highly correlated to the price of gold. However, their share prices are also affected by other factors such as the management of the company, along with the wider geopolitical, regulatory and environmental situation.

Investing in a mining company provides the opportunity for investors to make a profit if the share price rises, along with income in the form of dividends. Dividends are usually paid to shareholders in cash, once or twice a year. Mining companies were a key driver behind the record dividend payouts in 2021, thanks to the rise in commodity prices.

BHP Group and Rio Tinto, two of the larger mining companies listed on the London Stock Exchange, are currently trading at a dividend yield of 10% and 12% respectively. Dividend yield is calculated as last year’s dividend divided by the current share price, and is a proxy for the level of income or ‘return’ on the shares.

Should you invest in gold?

Gold may provide investors with a safe haven and a hedge against inflation, as well as diversifying their portfolio across different assets. The price of gold is volatile, as with shares, although it has substantially increased in value over the last 30 years.

Depending on your tolerance for risk, you could invest in physical gold, share in mining companies or gold-based funds and ETFs. However, any investment in gold should form part of a balanced and diversified portfolio.

Your investment can go down as well as up, and you lose some, or all, of your money. You should seek financial advice before deciding whether to invest.