Friday, October 01, 2010

Bullion funds

These are mutual funds or exchange-traded funds (ETFs) whose underlying assets are either physical gold itself, or certificates or futures that are directly exchangeable for gold. Their value closely tracks the price of the underlying gold, less annual management expenses (which run anywhere from 0.4 per cent for ETFs to as high as 3 per cent for some mutual funds).

You can move in and out of these holdings quickly and easily - mutual fund units can be bought and sold daily, while ETFs trade all day on the stock market just like stocks. However, keep in mind that every time you trade ETFs you'll incur broker fees, which can run anywhere from $5 to $30 per trade.

Fear: If a fund or fund provider goes under, your money and your gold will disappear.

Fact: You'll want to make sure the gold held in your fund is "allocated" - meaning it belongs not to the bank storing it, but to the fund's investors. As long as it is, you have nothing to worry about. If anything goes wrong with the fund, it's your gold, not the fund's or its creditors.

Flaw: Not all bullion funds invest strictly in physical gold - some hold a portion of their assets in other precious metals, gold-mining equities or even cash. If you want a pure play in the gold price, you'll want to make sure the fund you buy is committed to holding all its assets in physical gold in a vault. (On the mutual fund side, BMG Gold Bullion Fund does the trick; among ETFs, Claymore Gold Bullion ETF is your best bet.)

Gold certificates

Certificates are generally issued by banks (such as Bank of Nova Scotia and Royal Bank of Canada), and are directly exchangeable for either the physical metal held in the banks' vaults or their cash equivalent. At RBC, you'll pay a minimum of $43, plus the price of the gold, to buy certificates, which works out to about 0.66 per cent on the minimum certificate size of five ounces. You aren't charged any sales tax, storage or insurance fees for the underlying gold.

Fear: If the financial system melts down and banks and other institutions fail, the certificates might not be worth the paper they're written on.

Fact: U.S. gold commentator James DiGeorgia says some certificate issuers in the United States have gone bust, leaving the certificate holders with nothing. Most gold certificates are essentially promissory notes - the issuer is promising to exchange them for gold if you ask them to, but you don't own the gold. However, Scotiabank's precious-metals arm, ScotiaMocatta, does offer an RSP Gold Certificate in which the gold is allocated to the investor.

Flaw: As the recent financial crisis showed us, even big banks can run into trouble. If you're buying gold not just as an investment but as protection against a global financial-system catastrophe, you may want something more concrete.

Gold bars and coins

For many investors, buying physical gold is attractive on a visceral level. They know they have a hard asset at their fingertips that will surge in value should the world go to hell in a handbasket.

Fear: Storage of your own gold is risky, complicated and expensive.

Fact: Banks will hold your gold for you in registered, insured vaults at a cost of about 1.5 per cent of the gold's value per year. Or you can hold your gold yourself - a safety deposit box at a bank is advisable, and you can get one for under $100 a year.

Whether you keep your gold in a safe deposit box or at home, you'll want to be sure it's covered under your home insurance. If the amount of gold is large, it will mean additional insurance premiums, though insurers charge a lot less if they know you keep it in a safety deposit box.

If you hold larger bars yourself, you've removed them from the world's registered storage system, which means their purity can no longer be guaranteed. You'll have to pay to have them melted down by an authorized refiner, re-poured and audited for quality before you can sell them.

Flaw: Cost. Both bars and coins sell for about a 5-per-cent premium over the price of the gold they contain, plus sales taxes and dealer commissions. Then there's the cost of storage and insurance. Government minted coins such as the Canadian Maple Leaf and South African Krugerrand are readily recognized by coin dealers around the world - but reputable dealers are going to want to see detailed ownership documentation before buying them from you.

Gold futures

The commodity futures markets offer investors a way to play gold price fluctuations without the complications of actually owning the metal. Holders of futures are essentially committing to buying gold at the contract expiry date. But as long you sell the contract before expiration - or roll it over to the next contract - you never actually have to take delivery of any gold.

Fear: Mom-and-pop retail investors have no way to participate in commodity futures markets.

Fact: There are retail-focused brokers, such as Chicago-based Lind-Waldock (which has Canadian offices), who can put you in gold futures for relatively little cost - about $100 in total commissions for each contract you hold. A standard gold contract on the Comex division of the New York Mercantile Exchange is 100 ounces, which means it runs a daunting $130,000; but if you buy on margin, you're only required to put up about 5 per cent of that - about $6,000. And there is now an actively traded "mini" contract on Comex of 33 ounces, making entry more affordable.

Flaw: First, if you're making margin purchases, you're essentially borrowing the rest, and that's a lot of debt exposure for a small investor. Second, as we saw in the 2008 financial crisis, market panics can trigger margin calls that can make this a risky place to have your nest egg. Remember, you're holding derivatives paper, not the gold itself, so counterparty risk looms in the background. Consider gold futures more a trading tool than a long-term investment product.