I am not a gold bug.

But I have been around gold bugs and gold market enthusiasts for more than 30 years. From Doug Casey of Crisis Investing fame, to Adrian Day of Global Analyst and of course the godfather of gold investing in the U.S. — Jim Blanchard. Jim Blanchard fought for years to legalize the ownership of gold for Americans and eventually worked with President Richard Nixon to accomplish the feat back in the 1970s.

And I’ve also been friends with geologists and mining experts including Rick Rule, the CEO of Sprott’s (OTCMKTS:SPOXF) U.S. holdings.

Then on the investment fund front there was Ian McAvity, who was on the board and directed Central Fund, now Sprott Physical Gold and Silver Trust (NYSEMKT:CEF).

But up until June of last year, I had never recommended a gold investment. And now, I remain in my recommendation to buy and own gold — but in a very specific way.

Gold can be an emotional investment. Many folks have a want or need to own it as for them it is a better store of value than fiat currencies including the U.S. dollar. And those same investors will also view it as an inflation hedge. Still, others see it as an absolute asset to have for when the financial Armageddon strikes.

But I see gold differently. Gold to me is valued on some of the just-mentioned rationales — but it is more accurately priced based on more specific economic and market conditions.

Interest Rates and Gold

Interest rates are one of the biggest drivers for gold. Gold in and of itself does not earn a dime in interest or dividends. So, by buying and holding it you are incurring an important cost in opportunity lost in interest.

So, as interest rates in the U.S. rise, gold will tend to suffer as the pain of the lost opportunity of earning more interest drives away buyers. And in turn, when interest rates are low and falling, then the opportunity cost of holding gold drops and the demand to own it rises.

Look at the following graph that plots the price of gold and short-term U.S. dollar interest rates for the trailing year. Three-month London Interbank Offer Rate (LIBOR) is plotted in white and the spot price for gold is fittingly in gold.

12-Month History: Three-month LIBOR (White) and Spot Gold (Gold)

You can clearly see that as interest rates drop, gold is rising. And if you look at the same chart for the trailing three years, you’ll see that as interest rates climbed in 2017 and continued sharply into 2018, gold prices and the gold market were having a tough time.

36-Month History: Three-month LIBOR (White) and Spot Gold (Gold)

And U.S. inflation continues to remain low, as seen in the core U.S. Personal Consumption Expenditure Index (PCE). The Federal Reserve and its Open Market Committee (FOMC) uses this index as an inflation gauge.

U.S. Core Personal Consumption Expenditure Index

The FOMC made policy errors in 2018 as it acted to influence short-term U.S. interest rates. It raised the target range for Fed Funds — a benchmark market rate for banks to lend to one another. It reversed its mistake, and I expect that it will make further corrections to lower the target range resulting in lower U.S. interest rates. This should benefit the price of gold.

But the U.S. is just one of the primary markets for interest rates. And for the rest of the globe’s major markets in Europe and Asia, short- and longer-term interest rates are even lower than in the U.S. Many markets have negative yields.

Amount of Negative Yielding Debt in U.S. dollars

The amount of negative yielding debt and negative yielding bank deposits makes gold outside the U.S. all the more attractive to buy and own. That’s because it doesn’t have negative yields, making for a cheaper store of value and savings. And this buying helps gold prices in the U.S. as demand rises under this condition.

And given the slowdowns in European and Asian economies, including borderline recession or actual recessions, negative yields outside the U.S. aren’t going away for some time. This will continue to help gold demand.

U.S. Dollar and Gold

Gold for U.S. investors is priced in U.S. dollars. So, it makes sense that as the dollar rises in value, gold will feel the pinch. And as the dollar falls in value, gold will gain, all other factors aside.

Bloomberg U.S. Dollar Index (White) Spot Gold (Gold)

You can see that over the trailing five years, that the U.S. dollar and the spot price of gold have an inverted market relationship.

Back in 2015, the dollar was up, and the price of gold was lower. Then into early 2016 the dollar fell back, and gold rallied in price. Later in 2016, the dollar headed to recent highs and gold suffered in the market. Then as the dollar plunged in value in 2017 into 2018, gold was generally higher in price. And this reversed in mid-2018 until late in that year as the dollar slipped and gold went up.

For 2019, the dollar has been generally in a range. But again, you can see that as the dollar edged higher in that range, gold drifted lower. And in June 2019, the dollar was slipping again and gold did better.

But I believe that interest rates are right now more important for gold spot prices as U.S. rates head lower and global rates head deeper into negative territory.

Calamity in the Markets

Many think that gold makes for a good hedge during stock market calamity. But that really doesn’t pan out with history. Take for example the plunge in the S&P 500 in the fourth quarter of 2008. The S&P 500 dropped as the impact of the financial crisis took hold of stocks and sent them into the basement.

But gold didn’t do much better. It ended the year below the higher prices it saw earlier in 2008.

2008 S&P 500 (White) and Spot Gold (Gold)

And then we can look at the fourth quarter of 2018 when the S&P 500 had a full slip and slide. From my perspective, that market action was due to expectations that several companies would report lower sales and earnings growth.

2018 S&P 500 (White) and Spot Gold (Gold)

As the errant FOMC led U.S. interest rates higher, gold started to go down. And even during much of the heavy selling and the drop in the S&P 500 gold remained low. And only as selling begat more selling in mid-December did gold begin to rise a bit. Even then, it still was much lower than earlier in the year.

That said, market calamity can drive some demand for gold, particularly when the markets are dropping very heavily on any given day such as has been the case over the past few days. But one of the reasons for gold gaining might not be concerns about stocks, but rather concerns over the possibility of slowing U.S. economic growth. For example, fears that the coronavirus from China will have a major impact on the U.S. could take gold higher. And in turn, this would support even lower interest rates and a lower U.S. dollar.

All About Investing in Gold

There are several ways you can invest in gold. To start, you can buy coins, either in the form of bullion or in numismatic or collectable coins. You can buy allocated gold, where a certain amount of bullion becomes your explicit property. Or, you can own unallocated gold, which remains under the ownership of a bank. Here, you essentially have interest in a certain amount of gold in storage.

Coins have bid-offer rates and can also have commissions. And if you choose to have them delivered, you will also have shipping and insurance costs. This is perhaps not the best investment in my opinion unless you derive some personal benefit from holding coins.

Allocated gold comes with the benefit of ownership and the storage facilities are audited in that storage. But you will have bid-offer costs and you will incur storage fees which mean that gold not only has an opportunity cost to own it, but a further actual cost to store it.

As mentioned above, when you buy unallocated gold, a bank or financial firm is allowing you to buy and sell bullion. But instead of delivering it to your doorstep, it carries the gold on its books as an accounting item for you. Think of it as when you buy a stock and your broker holds the stock for you, journaling your holdings in your account. Here, you still pay bid-offer costs. But unallocated gold comes with lower — and sometimes no — storage costs. The firms will view the storage costs as their responsibility, absorbing the fees from the income they make off your transactions.

One of my long-time friends and former business partner from my banking days is Chris Gaffney. He is the president of world markets at TIAA Federal Savings Bank, which is part of the massive non-profit financial and retirement firm, TIAA. TIAA offers coins, but more importantly, unallocated gold with no storage fees and lower bid-offer costs. He and his team can be reached at 800-926-4922 (my old office number at Mark Twain Bank) or online, here.

Taking the Fund Route

Then you can look at a gold exchange-traded fund such as the SPDR Gold Shares (NYSEARCA:GLD) which synthetically holds gold bullion. This is a very easy means of buying and owning gold as more and more brokerages eliminate commissions. But it doesn’t mean that it’s free. That storage — either real or synthetic — comes into play for the ETF with an expense ratio of 0.40%, or $40 on an $10,000 investment. This means that you will have an actual cost to hold shares of the ETF, as it doesn’t pay a penny in dividends.

SPDR Gold Shares ETF (White) and Spot Gold (Gold)

GLD does track spot gold pretty well as you can see in the graph of the two. But that embedded cost represented in the expense ratio means that it will lag gold prices. And that gap widens over time as the expenses add up. Over the past five years GLD has lagged the Intercontinental Exchange’s (NYSE:ICE) benchmark price for gold by 4.5%.

Total Return SPDR Gold Shares GLD (White) and ICE benchmark price

A Better Way to Own Gold

There is another way to invest in gold. You could buy a mining company, but they come with all sorts of complications. What are the reserves, the costs of production, what are the hedging costs? They have all sorts of other financial risks and rewards just like for any other company that digs something out of the ground and gets it to the market.

But my recommendation that I presented to my Profitable Investing subscribers back in June 2019 isn’t a mining company. It is rather a company that owns and acquires royalties of gold production and interests in gold production. And in turn it generates cash flows from the stream of gold flowing across its books. It pays shareholders a cut of the profits throughout each year.

The company is Franco-Nevada (NYSE:FNV). Although it is based in Canada, it lists its shares in the U.S. markets. This company doesn’t operate any mines, so it has no capital expenditures to dig or prop up mines or any heavy equipment. Instead, it has an office in Toronto and just manages the gold flows and resulting cash flows and dividends.

The dividend isn’t high, as the distributions are running at 25 cents and are projected to increase in the next declaration to 26 cents. But at the current stock price the distributions yield 0.8%. That’s way better than zero. And it’s way better than less than zero when looking at the other fees and expenses involved in gold investing.

Total Return Franco-Nevada (White) and SPDR Gold Shares (Red)

And Franco-Nevada continues to outperform gold and the GLD ETF. Since I recommended the shares in June to date, Franco-Nevada has returned 40.6% including dividends compared to the return of GLD of only 15.4%.

So, if I’m going to recommend gold, I’m staying for now with Franco-Nevada for my Profitable Investing subscribers. And note, as a foreign company it should be held in a taxable account. Canada for now doesn’t withhold taxes for individual investors with qualified retirement accounts. But that could change as Ottawa has a history of quick and severe tax policy changes. And withholding taxes are generally easy to reconcile for taxable accounts, but for tax-free retirement accounts it does get harder. I err on the side of caution.

Neil George was once an all-star bond trader, but now he works morning and night to steer readers away from traps — and into safe, top-performing income investments. Neil’s new income program is a cash-generating machine … one that can help you collect $208 every day the market’s open. Neil does not have any holdings in the securities mentioned above.