This article is written by InvestorPlace’s Neil George.
For some investors, after years of patiently investing in gold, the market is finally seeing the light, and it’s buying.
The soaring nature of gold isn’t new of course. The last time the metal was soaring, it seemed like there was no top in sight.
Jimmy Carter listed his home at 1600 Pennsylvania Avenue at the time, and I found myself in Geneva. Switzerland, that is. And even as a young man, I was caught up in the near mania over the metal. In those days, the local banks wouldn’t be posting the time and temperature outside, but rather the price of gold.
You couldn’t ignore it, and many folks got completely caught up in the market with some incredible results.
But the end came, and it came quite hard. January of 1980 saw the peak at $850, and by March, the price was nearly halved, down into the $400 range.
Like that, the gold market ended, as investors moved on from the mania of gold back to the mania of stocks — at least until that trouble in the fall of ’87.
Before You Buy Gold, Read This
No, I’m not going to suggest that the end of gold is nigh. But I will suggest that there are two major additional elements in the current market that should be considered before buying gold.
Let’s set aside the usual discussion of supply and demand for gold as well as the ongoing traditional arguments for investing and owning the yellow metal. We all understand the basics.
Instead, my concern rests with the newcomers to the gold market. For it’s the newbies that can both help and hinder the market for gold.
Right now, there are two major drivers for newbies to be buying more gold:
1) The continuing concerns over the financial markets and the economies of the U.S. and the world.
We’re now two years into the financial meltdown that began in the summer of 2007 when the mortgage financing market began to crumble.
The resulting carnage across the globe set the stage for the surge in gold buying.
And while we’re not done yet with the core issues that continue to face the financial markets, we’re a whole lot closer to improvements than we are to another wave of Armageddon. So the question is can gold continue to soar higher even if we aren’t in a state of financial distress?
2) The second driver is the dollar.
Gold is of course a real good, just like any other commodity. As such, it gets priced in dollars and as the dollar slips and slides, real goods tend to rise in value.
Those that are trading on the premise of a doomsday for dollars are buying into the “gold-as-valuable-commodity” theory. But the concern is, how long will the dollar go down?
This surge in interest in investing and/or trading against the dollar isn’t new, and it has never been a pure one-way bet that’s worked.
And in time — just as in decades past — the dollar, of course, will again have its day.
When that happens, the newbies will sell, and sell hard. They will see the markets and economies around the globe gain stability and move into plenty of other alternatives.
The traditional gold investors won’t, and that will bring this market back to its longer-term fundamentals. But the pains could be harsh for the faithful, like they’ve been before.
Gold Funds Change the Game
But there’s another bit about investing in gold that you need to consider. Like other real assets, the gold market has been expanded by the availability of gold funds, and more specifically, exchange traded funds (ETFs).
And whether you’re a traditional gold investor or a newbie, you need to know what you’re actually buying when you’re eyeballing the wave of gold funds in the market.
ETFs, of course, can hold a host of underlying financial securities. And like any market, don’t assume that you know what’s inside an ETF until you actually see inside it – past the name on the prospectus or ticker on your online brokerage screen.
There are two ways that ETFs work the gold market. The first is the traditional way of simply buying a series of gold-derived securities. This can be as simple as investing in rolling futures contracts or as complex as forwards and swaps with financial firms and banks.
When you invest in an ETF that holds these securities, your investment is not tied directly to the price of gold. The spot market for gold might well continue to perform, but the underlying derivatives in this type of fund can do little or actually fall in value.
The PowerShares funds fall into this category. The PowerShares Deutschebank Gold ETF (DGL) is an index tracking ETF that, while positive during this recent market run, might well face some issues if the market begins to unravel again.
And its leveraged peer – an off-shoot of the ETF market – the PowerShares Deutschebank Gold Double Long (DGP) has an additional twist. This is not an ETF, but rather an ETN, an exchange traded note. As a note, it is debt, not equity. And its return will be based on the credit of the issuer, along with the embedded derived securities that make the note work.
Fortunately, there are other ways of buying into gold funds without the potential added drama.
Some ETFs invest in actual gold. The Comex Gold Trust (IAU) and the Spider Gold Trust (GLD) have, as some of their underlying assets, unallocated physical gold. Not a completely pure play, but with less derived securities, the drama is less than with the PowerShares ETF and ETN.
There is a newer ETF coming to the market that’s even more direct. The Physical Swiss Gold ETF (SGOL). Its assets are structured to result in an ownership in unallocated gold, with each ETF share representing 1/10th of an ounce of gold held in a depository back in Switzerland.
And no, don’t ask if you can just show up and take delivery. But it is a bit closer to owning gold.
And there’s another way that’s even more direct in the fund market for gold.
The Central Fund of Canada (CEF) has been on the market for a long time. It’s a closed-end structure, which I tend to prefer, as you get a direct share in the underlying assets. And my old comrade, Ian McAvity, is on the board of directors.
This fund has ownership in gold and silver bullion in a vault in Canada. And it’s not unallocated as in the ETFs, whereby the funds simply are listed as having a stake in gold holdings. Instead the gold is actually stacked off and is owned directly by the fund.
This fund trades at a premium, but the performance has proven to be worth it.
While both the Spider ETF and the Comex ETF have pretty much held up with the year’s performance in the spot market for gold, the Central Fund has continued to out-gun them by a margin of 37%. And that margin has been steady over the past 12 months and the past four years, with the average annual outperformance of Central Fund running consistently at over 23%.
Now please understand, I am not recommending gold. It’s still too risky for my taste. But if you are set on getting a piece of the gold action, the Central Fund and the Physical Swiss Gold ETF will give you the purest plays for your speculative money.
Neil George is the editor of Stocks That Pay You.