Investing in gold can be an exhilarating experience for the investor, and it can also be an overwhelming one. Investments in gold can take many forms such as coins, bullion bars, certificates, futures, options on futures, mining share, or precious metals mutual funds. Each vehicle offers advantages and disadvantages for the investor, and each features its own level of risk.

This guide will attempt to simplify some of the competing sales messages that todays investors receive on the subject of gold investments. A well informed investor is likely to return time and again to investing in gold, just as individuals the world over have done for thousands of years.

Historic Role of Gold

Golds unique physical properties, its luster, easy workability, and virtual indestructibility have given it a special place in the history of man. Over centuries, gold has been prized for its rarity and beauty. One of the earliest records of gold used as money dates from 560 BC, when King Croesus of Lydia created a coin emblazoned with his own image. Before coinage, hundreds of commodities were used for purchase; cattle, cocoa beans, shells and hides were just a few. As the idea of the guaranteed gold coin gained gradual acceptance, gold became the formalized basis of economic life.

Like ancient cultures, our modern society still recognizes the value and beauty of gold. Gold jewelry continues to adorn us, and gold is increasingly used by industry in electronics, dentistry and official coinage. Gold is an internationally recognized monetary and financial asset. Significantly, governments hold one-third of all the gold in existence. Even in the modern world economy, gold remains a source of financial stability.

Gold Supply

The supply of gold is limited by nature of itself: Thousands of pounds of ore are required to produce just one precious ounce. Gold is so scarce that all the gold that has ever been mined (approximately 110,000 metric tons) would fit into a cube measuring just 20 yards on each side.

What’s more, the amount of new gold mined each year is relatively small despite the use of advanced mining technology. New supplies generally add less than 2% per year to the worlds total stock of gold. Eighty-five per cent of new supplies comes from the top ten gold-producing nations.

Top Ten Gold Producing Countries

1. South Africa
2. United States
3. Australia
4. Russia
5. Canada
6. China
7. Brazil
8. Uzbekistan
9. Papua New Guinea
10. Indonesia

Source: Gold Fields Mineral Services

In addition to new mine production, there are three other major components which make up the available supply of gold each year: 1) reclaimed scrap, 2) bullion sales from private investors, and 3) official sales.

Scrap includes gold reclaimed from jewelry and other industries such as electronics and dentistry. The Middle East is the largest source of gold scrap, primarily from jewelry.

Depending upon market circumstances, investors can also sell their holdings, thus adding to the supply of above-ground gold. This supply of gold is highly sensitive to the gold price. A higher gold price encourages investors to liquidate their holdings.

Finally, governments and official institutions can also be net sellers of gold. World official sector activity is a dynamic process that combines both purchases and sales of gold. Over the long term, official sector reserves have remained remarkably stable. However, in some years, official sales have accounted for as much as 15% of the total supply of gold.

Reasons for reducing a countrys national gold reserves ranges from distress selling to portfolio reallocation of a nations reserve assets. On some occasions, the gold used for minting legal tender coins can come from official reserves.

There are four major sources of demand for gold: 1) jewelry fabrication, 2) industrial applications, 3) governments and central banks, and 4) private investors. The largest source of demand is the jewelry industry. In recent years, demand from the jewelry industry alone has exceeded Western mine production. This shortfall has been bridged by supplies from reclaimed jewelry and other industrial scrap, as well as the release of official sector reserves. Golds workability, unique beauty, and universal appeal make this rare precious metal the favorite of jewelers all over the world.

Besides jewelry, gold has many applications in a variety of industries including aerospace, medicine, electronics and dentistry. The electronics industry needs gold for the manufacture of computers, telephones, televisions, and other equipment. Golds unique properties provide superior electrical conducting qualities and corrosion resistance, which are required in the manufacture of sophisticated electronic circuitry. In dentistry, gold alloys are popular because they are highly resistant to corrosion and tarnish. For this reason gold alloys are used for crowns, bridges, gold inlays, and partial dentures.

The third source of gold demand is governments and central banks that buy gold to increase their official reserves. Finally, there are private investors. Depending upon market circumstances, the investment component of demand can vary substantially from year to year.

MARKET FORCES

How the Gold Price is Determined

Golds performance is reported every day in the major newspapers in the United States and around the world along with prices for stocks, bonds, mutual funds, commodity futures and options. Quotations form the formal markets in Hong Kong, Tokyo, Zurich, Frankfurt, Paris, London, and New York are published daily. Gold also trades informally in the street markets of Dubai, and in the gold fields of the Amazon.

Generally speaking, the gold market responds to shortages, or the perception of shortages, by moving the price higher. Likewise, the market reacts to a larger than normal supply of gold for sale in the marketplace by moving the price lower. The price for gold is determined by the sum of all buying and selling activity known to the market at any moment in time. Traders around the globe assess this information from minute to minute and quote prices for gold that reflect the current activity in the market.

Gold Trading Markets

The most influential gold market is based on physical bullion. Bullion is the basic commodity in the spot or cash market (current delivery). The bullion market is traded on a worldwide basis. The major centers are London, New York, Hong Kong and Zurich. The London gold market is anchored by its twice-daily gold fixing (known as the London AM or PM fix), which is the most frequently quoted gold price in the world. These market centers also offer trading in forwards and options, discussed later.

The second most influential market is the futures market. The New York Mercantile Exchange COMEX Division is the most famous of futures markets. In 1994, the COMDEX Division become a subsidiary of The New York Mercantile Exchange (NYMEX). This merger created the worlds largest precious metals exchange, offering trading in silver, platinum, palladium, and of course gold. Other gold futures markets are located in Tokyo, Hong Kong and Sao Paulo.

Investing in Gold

The reasons for investing in gold have remained much the same over its long history:

• Gold is a safe haven in times of economic and financial instability.
• Gold is a proven asset diversifier that, when included in domestic portfolios, reduces the portfolios overall risk.
• Gold can be a good stand-alone investment based on its supply and demand fundamentals and market circumstances.
• Gold is a hedge against inflation over the long term.

Golds Usefulness as a Safe Haven

The geo-political and world economic structure is currently undergoing major change some have even called the situation an upheaval. This means that the investment outlook, particularly for certain parts of the world, is more unpredictable than usual. Under these circumstances, it is logical to conclude that certain investment portfolios should include real (non-paper) assets such as commodities for protection against a potential decline in the paper markets.

Golds Usefulness as Asset Diversifier

Most portfolios are invested primarily in traditional financial assets such as stocks, bonds and mutual funds. Adding gold to a portfolio introduces an entirely different asset a tangible or real asset thus increasing the portfolios degree of diversification. The purpose of diversification is to protect the total portfolio against fluctuations in the value of any one type of asset. Gold does exactly that.

The reason is basic: the economic forces which determine the price of gold are different from, and in many cases opposed to, the forces which determine the prices of most financial assets. The price of an equity depends on the earnings and growth potential of the company it represents. Likewise, the price of a bond depends on its safety, its yield, and the yields of competing fixed income investments.

The price of gold. on the other hand, depends on different factors: worldwide physical supply and demand for gold, movements in foreign exchange rates, inflation, interest rates and political turmoil. The effects of all these factors are somewhat complex and variable. But the important point to remember is simply that they cause the price of gold to move independently of the prices of financial assets.

Golds Attractiveness as a Stand-Alone Investment

So far this discussion has involved gold as an asset to be included as part of a portfolio; yet on some occasions, gold can be a good stand-alone investment. Many analysts have pointed to what they believe is a widening gap between the physical demand for gold and new supplies of gold leading to a situation of excess demand. Other analysts look upon gold favorably when they believe its price is undervalued relative to other assets such as stocks and bonds, or when they believe gold to be a safe-haven investment.

Gold as a Hedge Against Inflation

The purchasing power of gold has been remarkably stable over the long run, whereas the purchasing power of the U.S. Dollar has steadily declined.

A Secure Foundation for a Balanced Portfolio

Whether your investment approach is conservative or aggressive, gold can play a vital role in your portfolio. For this reason, many experts urge investors to keep at least 5-10% of their total assets in gold. Gold is part of a secure foundation for every investor average, aggressive or conservative.

INVESTMENT FORMS

Gold Bullion

If the idea of taking possession of your gold or having direct control of your assets appeals to you, then you may wish to consider buying physical bullion. International refiners make it convenient for investors to own bullion by offering gold bars in a variety of weights and sizes ranging from 1 gram to the popular kilobar (32.15 troy ounces), to the international London good delivery bar (400 troy ounces). One troy ounce equals 1.09714 regular (avoirdupois) ounces.

Broker commissions on buying and selling gold bars are minimal, and in most cases, purchasing bullion is the most cost-efficient means of owning gold. Bars bearing the hallmark (logo) of internationally recognized refiners are the easiest to sell. These refiners assay or test the metal for its purity or fineness. The bars are generally stamped .995 (99.5% pure gold) or higher purity, along with the individual bars weight. Gold bullion bars can be purchased from certain commercial banks, brokerage houses, and precious metals dealers. For a list of the worlds major refiners, contact your investment advisor.

Gold Bullion Coins

For investors who enjoy investing in physical bullion, owning bullion is both enjoyable and convenient. Buying bullion coins is popular among medium and small investors. Gold Bullion coins are legal tender of the country of issuance, and their gold content is guaranteed. The bullion coin bears a face value that is largely symbolic; its true value depends on its gold content and the day-to-day changing price for gold. While bullion coins are also appreciated for their artistic appeal and beauty.

Bullion coins are minted in affordable weights such as 1/20, 1/10, 1/4, 1/2 and one ounce. Coins make memorable gifts. The bullion coin represents an investment in pure gold, and because it is legal tender, its authenticity is guaranteed by the country of origin. Gold bullion coins can be easily bought and sold virtually anywhere in the world. Prices for bullion coins are based on the underlying price of gold bullion, plus a small premium of approximately 4-8%. Some of the most popular bullion coins are the American

Eagle, Australian Kangaroo Nugget, the Canadian Maple Leaf, and the South African Krugerrand. Banks and dealers make a market to both buy and sell these bullion coins in much the same way as they do for regular bullion.

Numismatic Coins

Unlike bullion coins that are valued solely on the basis of their gold weight, the value of a numismatic gold coins is determined by several factors: its rarity, the number of coins originally minted, the age of the coin and its condition. Numismatic coins are bought and sold within the coin collecting community with little regard for todays gold price. Numismatic coins are cherished for their beauty, historical significance and their potential investment value. Hence, numismatic coins sell at a significant premium over their intrinsic gold content.

Glossary of Gold and Investment Terms