The Many Ways to Invest in Gold

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Published: Monday, 29 Aug 2011 | 3:34 PM ET

Futures, Options, and ETFs

Futures and options

Many countries support trading in gold futures. These are binding commitments to make or take delivery of gold on a specified date at an agreed price. The advantage: leverage. Trading on margin (a cash deposit paid to your broker) is less expensive than the price of the contract. ?

In New York, the New York Mercantile Exchange Comex Division (recently rebounded CME Globex, and now a unit of the CME Group ), is the principle venue for trading gold future contracts in the U.S.

But the U.S. isn't the only place gold futures are traded. The Dubai Gold & Commodity Exchange, DGCX), the Multi Commodity Exchange, MCX, in Mumbai, the Tokyo Commodity Exchange, TOCOM, and the National Commodity Exchange Limited in Karachi all support trading in gold futures.

To directly trade gold futures you need a futures trading account.

Gold options give the holder the right, but not the obligation, to buy or sell a specified quantity of gold, at a predetermined price, by an agreed date.

Exchange traded products

There are now many ways to invest in gold without the need to take physical possession.

Exchange Traded Funds, ETFs, are designed to track the spot price of gold and are backed by bullion held in vaults. They include:

SPDR Gold Shares, far and away the largest, sponsored by World Gold Trust Services (wholly owned by the World Gold Council), a trust backed by gold held in a vault in London (see the section on "Answering questions on gold ETFs" below).

  • iShares Gold Trust, also a trust backed by gold bullion.
  • ETFS Physical Swiss Gold, which is backed by gold bullion held in Switzerland.
  • ETFS Asian Gold, which is backed by gold held in Singapore.
  • PowerShares DB Gold, which is composed of futures contracts on gold.

The Central Fund of Canada and the Central Gold Trust are Canadian closed-end funds. The CEF holds a mix of gold and silver in about equal amounts; the GTU holds primarily gold.

The Sprott Physical Gold Trust, while legally a trust, trades as a closed-end fund. It holds physical gold stored at the Royal Canadian Mint. This fund, unlike the others, allows shares to be redeemed for whole gold bars, but only whole bars.

Mining companies.

This seems fairly simple, since if the price of gold rises, and a mining company can produce gold at a relatively fixed price, its profits should rise.

In theory, gold mining companies can produce "alpha" — returns in excess of the price of gold simply rising. They can do this by purchasing and selling other gold companies and mines and by reducing costs, for example.

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Unfortunately, it's not nearly that simple. Mining companies have their own forms of risk:

Corporate risk. They are subject to the usual corporate risk of mismanagement and miscalculation.

Commercial risk. Mining is inherently dangerous and subject to flooding, cave-ins, and explosions; mining companies can and have been sued many times for dangerous working conditions.

Political risk. As with oil, the more profit that is made from gold, the more pressure there is to share those profits. Many countries are putting more pressure on mining companies to increase the amount paid to them.

Production risk. Different mines produce gold at greatly different costs, depending upon what country they are in, depth of the mine, difficulty of getting at the gold, taxation, etc. For example, according to the GFMS Gold Survey 2011, most Latin American mines can produce an ounce of gold at a cost of about $400 an ounce. South Africa, by comparison, produced gold at close to $800 an ounce. Infrastructure challenges and electricity problems can cramp production as well.

Hedging risk. Unhedged mining companies leave themselves open to fluctuations in the price of gold, which means their profits can swing wildly from year to year. Many mining companies adopted aggressive hedging strategies to smooth out their earnings. However, when the price of gold began skyrocketing several years ago, many gold companies began taking off their hedges. Gold miners have generally benefited from removing hedges, but the cost of doing so has been enormous.

From physical coins to futures, options, and ETFs -- reporter Bob Pisani breaks down  the how and where to invest in gold. 
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