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  • Writer's pictureElias Zeekeh, MBA, CPA, CMA

Reasons to Buy Gold and How

So what are the good reasons to invest in gold?

Firstly, to protect against inflation. Over the long run most currencies have depreciated relative to gold, as many major governments have run big deficits all around the world and printed money for ever expanding government programs. In this situation gold tends to become relatively more valuable to currencies as it can't be replicated with a magic wand like money is. The US government has already shelled out trillions of $ in economic stimulus, and it could be trillions more to prop up the economy until business returns to normal.

Secondly, gold is used for portfolio diversification as it's thought of as having a low correlation with the stock market. For example, the most popular gold ETF GLD has a correlation co-efficient of 0.14 with the S&P 500. That said this correlation can vary widely, and correlations have been shown to swing all the way from -1.0 to +1.0.

A correlation of +1.0 indicates that they are moving in the same direction, and -1.0 indicates they are moving in the opposite direction. So if the correlation is +1.0, and the stock market moves up 1% gold would be move up 1%, and conversely the opposite for a negative correlation. Therefore, while it is used for portfolio diversification, due to the volatility of this correlation it isn't necessarily the best hedge against a stock portfolio.

Thirdly, during times of geo-political conflict or wars gold can perform very well. Uncertainty is good for gold prices. This partly explains the rise the recent rise in gold prices during the pandemic. During the beginning of the year gold prices were around the mid $1500s now we're close we're just over the $1700 mark. For example, after the 9/11 attacks the price of gold went up almost 33 percent in one day, and gold ended up going on a bull run for roughly a decade going up roughly 4x, which was also fueled by the financial crisis in 2008-2009.

It should also be noted though that is not always the case. So for example during the Paris Terrorist attacks there was a pop in gold, but it did not last. Gold prices tend to forward anticipate conflict, so you can run into the phenomenon of people buying the rumor and selling the news just like the stock market. Therefore it is probably better to buy gold on fundamental principles for things that are likely to endure rather than individual geopolitical events, as by that time it could be too late, and you've missed the pop.

Furthermore, a couple other reasons that people might want to buy gold is because it is a tangible asset that is liquid. If you're buying physical gold it can't be hacked or misused, and this provides a perception of safety. Additionally, it is also liquid relative to other physical assets such as real estate.

So what are the ways the ways one can gain gold exposure.

Firstly, purchasing gold mining stocks. This would be the riskiest because there is operational risk to mining operations that makes buying gold stocks more volatile than other alternatives of getting gold exposure. There can also be a high degree of political risk depending on where the gold miner operates. There have historically been issues in developing countries. That said with that risk can come reward, which is why some people invest directly in miners.

Secondly, you can purchase gold streaming company stocks. What a gold streamer does it that it makes a contractual agreement to purchase gold from a mining company at a predetermined price. This helps to finance gold miners in need of capital. The operational risk and potential cost over-runs is on the miner, and the profit margin of the streamer is based on the price of gold. Therefore, it is less risky than buying stock in a mining company, but at the same time relatively more risky than purchasing the physical asset. Three gold streaming companies are Franco Nevada, Wheaton Precious Metals, and Royal Gold.

Thirdly, Is to purchase an ETF like GLD which is backed by physical bars or purchasing the physical bars themselves. Off course, if you purchase the ETF there are fees associated with that which are currently 0.40%. If you purchase the physical asset though you'll likely need to pay for secure storage as well as insurance. This is the least risky, but safest of the three options.

So do you invest gold? If so how do you invest and why? Are there any specific strategies that you're applying right now? Please leave your comments below.


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