Be Cautious When Investing in Gold

By Monument Wealth Management Team | Sep 02, 2011 | Featured Articles, Invest My Wealth

Gold might be in the headlines, but should it be in your portfolio? Here are some things to consider when investing in gold.

It has been hard to go about your daily routine in the last year without being overwhelmed with news about gold. It seems like it’s everywhere: TV, radio, billboards, pop-up ads, magazine covers, and talk shows. I even saw a guy on the street corner with a sign exclaiming, “We’ll Buy Your Gold Now!”

While some folks are digging out their high school rings and other jewelry to rake in some fast cash, others are looking for a different way to profit from this unusual time. When it comes to investing in a precious metal such as gold, you’ve got a variety of choices. Anyone can consider investing directly in the commodity or indirectly through investment products such as exchange-traded funds (ETFs) or mutual funds that invest in mining companies. But it’s important to understand that your returns may vary significantly depending on the type of exposure to gold you choose.

Gold’s Performance

Let’s first look at the performance of the metal itself. Since the beginning of the year, gold has gone from approximately $1,400 an ounce to about $1,800 an ounce, a roughly 28 percent gain. If you look at SPDR Gold Shares (symbol GLD)—the largest physically-backed gold ETF—you’ll find very similar results, minus fund expenses. By comparison, look at Market Vectors Gold Miners ETF (GDX), which provides exposure to publicly traded gold mining companies worldwide. It holds a diversified mix of small-, mid-, and large-cap companies. Since the beginning of the year, the performance of GDX has been up less than 2 percent—not even close to the performance of the bullion.

Variables of Gold Mining

Here’s the problem. The price movement of the shares of gold mining companies depends on a number of variables, with the price of gold being only one of them. Pricing a mining company is far more difficult because mining companies are priced in line with what are considered “proven reserves”—what the company has demonstrated they have found—and, to a lesser extent, their “unproven reserves,” which includes what they think they have found. As you might expect, unproven reserves can sometimes become nonexistent. Add in the expense of exploration and extraction, and overall costs can vary significantly from projections. The political risks are also worth noting as most of the mining is in foreign countries, and the risk of having the companies “nationalized” should be considered.

Gold is Being Depleted

The other issue that all mining companies face is that every day they are depleting the asset that makes them a business in the first place. They must find new sources or they will work themselves right out of business. This need to continue to reproduce proven reserves makes for a very active acquisition strategy for most large mining companies. It’s much easier to purchase a smaller mining company that has taken the risk of exploration and has some sort of proven reserves than spending a lot of money and coming up empty.

This aggressive acquisition strategy has been a well-known fact of life in the mining industry for years. Fortunes have been made by picking the right exploration company and having it bought out by a much larger company. These success stories are what every investor would love to be a part of. As you can imagine, there are many that don’t work out. Unfortunately, the greed factor is also present from people who aren’t looking out for your best interest, but are only looking for your money.

This has gotten the attention of The Financial Industry Regulatory Authority (FINRA), which just issued a new alert called “Gold Stocks—Some Investments Mine Your Pocketbook.” FINRA’s alert cautions investors to be on the lookout for any pitch for a gold investment that:

• Claims to tie stock performance to the general rise in gold prices
• Uses scare tactics such as the threat of inflation or an economic meltdown
• Makes speculative claims based on a new reserve’s proximity to an existing reserve
• Centers on a company that has changed its name or trading symbol to align it more closely with gold

 

Read this article on U.S. News & World Report >

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate please consult your financial advisor prior to investing. All performance references are historical and are not a guarantee of future results. Strategies involving asset allocation and diversification do not ensure a profit or protect against a loss.

This piece is not intended to dissuade investors from purchasing mining companies or mutual funds that invest in mining companies, but rather to help investors understand what they are investing in and how those investments may or may not track the price of gold.

Investors should consider the investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other important information. You can obtain a prospectus from your financial representative. Read carefully before investing. An investment in Exchange Traded Funds (ETF), structured as a mutual fund or unit investment trust, involves the risk of losing money and should be considered as part of an overall program, not a complete investment program. An investment in ETFs involves additional risks such as not diversified, price volatility, competitive industry pressure, international political and economic developments, possible trading halts, and index tracking errors. ETFs concentrating in specific industries are subject to higher risks and volatility than those that invest more broadly. Investing in mutual funds involves risk, including possible loss of principal. The fund’s concentrated holdings will subject it to greater volatility than a fund that invests more broadly. The fast price swings of commodities will result in significant volatility in an investor’s holdings.