How to invest in gold

The luster of gold has fascinated people since antiquity, but exactly what, besides its beauty, makes gold so special and valuable?

• One thing that makes gold valuable is its rarity. Since the beginning of civilization, less than 200,000 metric tons of gold have been produced – for comparison, the world produces this amount of copper every few days, or this amount of steel in about one hour. Gold is difficult and costly to extract, as it may take a rock weighing several tons to yield enough gold for a 1 troy ounce (31 gram) gold coin. Yet, gold in the Earth's crust is still plentiful enough to provide a steady supply to meet new demand. In recent years, global gold production totaled about 3,000 tons annually.
• Even more important than rarity is the fact that gold is extremely durable. It reacts with very few other elements, meaning it does not corrode or decompose. And unlike other commodities – such as grains that are ultimately eaten or oil that is burned up in engines – gold is not consumed or used up. In fact, of all the gold ever extracted, an estimated 85% is still currently in use. Even if currently locked up in electronic devices or jewelry, gold can be – and most likely will be – recycled into tomorrow's gold bars and coins.
• Although many have spent a lifetime trying, gold cannot be created through a chemical process in a lab. This means that its supply, unlike that of paper money, cannot easily be artificially increased. Gold is also near-impossible to credibly fake, unlike other assets such as fine art (or paper money).

For all of these reasons, gold is considered an excellent store of value; a given amount of gold will buy you more or less the same amount of goods or services today as it would have a hundred years ago.

Because of its properties, gold was a natural choice as a currency throughout history: either directly in the form of gold coins, or as a standard against which other currency forms – such as paper money or less valuable coins – could be measured, and for which they could be exchanged. The mechanism when paper money is backed by gold held in central banks is called the gold standard.

Partly because of its inflexibility in an era of rapid economic growth, most countries abandoned the gold standard by the first half of the 20th century, and instead pegged their currencies to the US dollar, as the US continued to back its currency by gold reserves. Feeling constrained by fixed exchange rates, the US also finally abolished the gold standard in 1971. As a result, all of the world's currencies are now fiat currencies (from the Latin word fiat, "let it be"), meaning they have a certain value simply because the government says so; and forex rates are entirely market-based.

Despite the move away from the gold standard, many central banks still hold some gold to diversify their reserves (nowadays dominated by US dollars or the euro), and are important buyers and sellers on the gold market. By far the biggest gold reserve is still held by the US, at more than 8,000 tons; followed by Germany, Italy, France, Russia and China. Gold still accounts for more than 70% of central bank reserves in the US or Germany, but less than 4% in China or Japan.

So we have an asset that retains its value extremely well over time, and which has basically no "fundamentals" to seriously impact the price. Before we discuss how to invest in gold in practice, let's see how you can benefit from these features as an investor.

Insurance against inflation

One simple and obvious reason to keep gold in your investment portfolio is to safeguard against inflation and currency depreciation. If prices across the economy rise and the purchasing power of the currency falls, investors will often turn to "hard assets" that keep their value well over time, such as gold, real estate, or art and other collectibles. Of these, gold is often the most convenient, because unlike many other hard assets, it is available in relatively small denominations, it is easily handled (even in physical form), and it is not influenced by other fundamentals such as location in the case of real estate. So if inflation accelerates, the price of gold in your portfolio is likely to rise due to higher demand from investors; mitigating losses in the value of the rest of your assets because of inflation.

As gold prices are denominated in US dollars, the weakening of the US dollar against other currencies will also raise the price of gold, because non-US investors (including central banks) will find it cheaper to buy; and the demand they generate will lift the price of gold. However, this is not an automatic correlation, as there may be cases when both the US dollar and gold prices strengthen.

Inflation is often associated with a high interest-rate environment, but gold can also be a useful – or at least neutral – asset when interest rates and bond yields are close to zero or even negative. This is because in such cases, the fact that gold doesn't generate an income is no longer a disadvantage vis-a-vis government bonds. In fact, data show that gold prices have moved in tandem with the global volume of negative-yielding debt most of the time.

Safe haven

Just as in the case of rising inflation, investors also tend to turn to gold investment when the stock market is falling. More broadly, gold can also serve as a safe haven when markets are volatile; in cases of geopolitical uncertainty; or when concerns intensify about the viability of the entire financial system, as was the case during the 2007-09 financial crisis.

Of course, as with real-life safe harbors, gold's safe-haven function will benefit you most if you think ahead and accumulate gold holdings in quieter times or during a stock market boom. If you find yourself scrambling to buy gold when markets are collapsing around you, it means you are probably already too late.

All that glitters is not gold. When it comes to gold itself, it may not always deliver on its promises, and may not always be the best instrument to achieve your investment goals, be it a hedge against inflation or protection from market volatility.

Price volatility

One problem with gold is that its price can often be volatile in the short run. This is partly because the market for investment gold is very concentrated. It is basically moved by a few dozen large central banks and gold-based mutual funds and ETFs (more about these later); a handful of large transactions by these can easily throw off the spot price of gold. And while market volatility is a fact of life, it is less acceptable for an asset that is supposed to protect you against market volatility in the first place.

Long-term performance vs bonds, stocks

The case for gold investment for the long term has also been called into doubt. According to some calculations, stocks and bonds have both often outperformed gold over the long term (especially when including reinvested dividends, as shown in these charts); meaning that there may be no need to diversify your long-term portfolio with gold at all.

Part of the reason for gold's poor long-term performance is that it is an unproductive asset, with no underlying growth potential. The price of a new tech stock may multiple in a few years' time on the strength of its business model or its global expansion; but gold is just a piece of metal, with its price dependent entirely on supply and demand and therefore unlikely to show such consistent and steep long-term growth.

Gold is also an imperfect safe haven instrument. Of all demand for gold, only about 40% is for investment purposes; while 50% is used for jewelry and 10% for industrial purposes, such as electronic components. Demand for gold jewelry and electronics generally rises and falls with the general health of the economy – witness the demand for gold jewelry in some emerging economies such as India – therefore watering down gold's anti-cyclical properties.

Not always the best option

Gold is just one of several asset classes with safe-haven potential. Other, often less volatile and less complicated alternatives include "defensive stocks" that hold up well in times of crisis such as utilities or consumer goods; currencies like the Swiss franc that are backed by a solid financial system; or even simple (and risk-free) US Treasury bills.

Gold is also not the only asset that can shield you against inflation. Inflation-indexed bonds (such as US Treasury Inflation-Protected Securities, or TIPS) may also do the trick, often without the volatility of gold prices. If you live in the US, TIPS may also work out better tax-wise than gold investments. To learn more about these government debt instruments, see our article “What is a bond”.

So what is the ideal role of gold in an investment portfolio? Lacking long-term growth potential and often moving in an opposite direction than the rest of the market, gold is probably best used for diversification – helping you mitigate losses and preserve the value of your holdings even in the face of adverse conditions.

How to invest in gold and how much to hold of course depends on your time horizon, investment goals, and the composition of the rest of your portfolio. Most experts discussing how to invest in gold will advise you to keep a few percent, but probably no more than 10% of your holdings in gold. For example, veteran hedge-fund manager Ray Dalio’s All Weather Portfolio – one of the best-known examples of a diversified, recession- and inflation-proof portfolio – calls for a 7.5% share of gold, in addition to 40% long-term bonds, 30% stocks, 15% intermediate-term bonds and 7.5% commodities.

How to invest in gold? There are several ways to do so, from buying the actual thing in physical form, to buying a piece of paper that represents gold, or buying into a fund that tracks a stock index of companies that are active in gold mining. Each comes with their own benefits and risks, so it makes sense to weigh your options and risk appetite before committing any funds.

ETFs and mutual funds

The most convenient way of investing in gold is via gold-based exchange-traded funds (ETFs) or mutual funds. The most straightforward gold ETFs basically work like "gold stocks" – instruments that replicate movements in the price of gold and can be traded on an exchange like any regular stock.

Not all gold ETFs invest in physical gold only; underlying assets may also include gold futures contracts or may track gold mining company stocks. Check out this article for a detailed breakdown of investing in gold-related ETFs and mutual funds.

Mining company stocks

A good way to gain exposure to gold as an investor is to buy shares in gold mining companies. There are hundreds of publicly-listed gold miners to choose from, from global behemoths to small-cap firms still focusing mostly on exploration; and their shares can be easily bought or sold on any online broker platform. Go here to read about the benefits and hazards of buying into these companies.

Physical gold

The most traditional way to buy gold is in physical form, in the shape of solid gold bars or coins. Special cases of physical gold investment include jewelry and numismatic coins. We collected the most important aspects of investing in physical gold in this article.

Gold futures

Gold futures are another, more sophisticated way to bet on movements in the price of gold. These are contracts to buy or sell gold at an agreed price at an agreed time (though actual delivery rarely takes place). As these contracts involve trading on margin and therefore may lead to sizable losses, they are not recommended for any but the most experienced and risk-tolerant retail investors.

How do I buy shares in gold?

The most convenient way to buy into the gold market is to invest in gold-based ETFs (exchange-traded funds), preferably ones that hold only physical gold as an underlying asset. Some people consider buying gold bars or coins a safer option, but this involves higher costs and more hassle.

When do gold prices rise?

As gold is widely considered a “safe haven,” investor interest in gold (and therefore its price) tends to rise in times of uncertainty or a stock-market downturn, such as those brought on by the Covid-19 pandemic in the first half of 2020.

What was the highest price of gold in history?

In absolute terms, the highest gold price was $2,067.15/oz in August 2020, at a time of global economic uncertainty and US dollar weakness. When adjusted for inflation, gold prices topped out at the beginning of 1980 (at more than $2,200/oz in today’s dollars), amid serious geopolitical conflicts and runaway US inflation.  

Why was gold so cheap in 2000?

The price of gold bottomed out at about $260/oz in 2000. This was because of a booming stock market (the infamous dot-com bubble) and a strong US dollar, both of which tend to weaken demand for gold. Demand for gold from Asian investors was also low, as the region was still reeling from the 1997-98 Asian financial crisis.

Is gold safer than cash?

Gold keeps its value better than cash, which is vulnerable to inflation or currency devaluation. However, gold – especially in physical form – can be costly to hold; short-term price fluctuations may be considerable; and the price of gold may fall if the economy or the stock market are booming. For these reasons, gold may serve you best as part of a diversified portfolio of assets.