How to Invest in Gold the Right Way

Gold has been a store of value for thousands of years, but the idea of gold as an investment generates plenty of controversy. Warren Buffett has argued that gold is far inferior to stocks as an investment, but others note that the yellow metal has risen in value over time and has a safe-haven status to protect against loss of confidence in financial systems. If you want gold as part of your investment portfolio, you can pick from several smart gold investing choices, each of which has different investment characteristics. Below, we'll go through five ways you can invest in gold and give you the information you need to decide the best one for you.

1. Physical gold bullion

For many gold investors, there's no alternative to having actual physical metal in your possession. A variety of gold coins and bars are available from government mints and private sellers, and you can typically purchase them from coin dealers and other precious-metals retail specialists.

Image source: Getty Images.

The biggest benefit of physical gold is that you own it directly, without any intermediary between you and your investment. Yet physical gold also has challenges, as you have to find a secure way to store it, which can be costly. Also, most dealers charge premiums to the bullion's value when you buy coins or bars, and you might receive less than the prevailing gold price when you sell.

2. Gold exchange-traded funds

For those who don't need to hold their gold directly, gold ETFs offer more liquidity. SPDR Gold Trust (NYSEMKT: GLD), for instance, has shares that represent a bit less than a 10th of an ounce of gold. The ETF owns physical gold and stores it, acting as support for the value of the ETF shares.

The benefit of gold ETFs is that you can buy or sell shares anytime the stock market is open, and the transaction costs are a lot lower than with physical bullion purchases and sales. However, some gold investors don't like ETFs because they are still a financial asset and give you no actual claim to the physical gold that the ETF owns.

Image source: Getty Images.

3. Gold futures contracts

If you want to have control over a lot of gold, futures contracts are a low-cost alternative, albeit with special risks. Gold futures contracts at the New York Mercantile Exchange come in units of 100 ounces, worth almost $130,000 at current prices. However, to open a position, all you need is a much smaller initial margin investment, and you also have to maintain a minimum margin level. Currently, the maintenance margin on the NYMEX is $4,200, or just 3% of the value of the contract.

As you can see, margin offers considerable leverage for investors. But you're still responsible for losses up to the full value of the futures contract, and you can be required to make additional cash deposits to cover losses. For some, the potential rewards outweigh the risks.

4. Gold mining stocks

The problem with directly investing in gold is that the metal doesn't produce any income. Gold mining stocks, however, are active businesses, and although their prospects are linked to gold prices, mining companies can also rise when they have fundamental success in their operations. Moreover, most mining stocks go up more sharply than gold during periods of rising prices.

Image source: Newmont Mining.

However, gold mining stocks have added risks beyond bullion investments. Even if gold rises, a mining stock can plunge if a catastrophic event happens to the mining company's business, such as a mine accident or the failure of a promising exploratory effort. Moreover, when gold falls, some mining stocks have even greater downward volatility.

5. Gold streaming companies

One hybrid way to invest in gold is to buy shares of gold streaming companies. These companies don't mine gold, but they provide financing to mining companies in exchange for a share of their gold production.

The benefit of streaming companies is that they have exposure to gold prices but also get a stream of income from their financing arrangements. For instance, streaming company Franco-Nevada (NYSE: FNV) has steadily raised its dividend for nearly a decade, and although Franco-Nevada's current yield of around 1.3% is less than the market average, it's quite a bit better than what most gold mining stocks pay. Similarly, Royal Gold (NASDAQ: RGLD) is a competitor to Franco-Nevada and has made smart gold streaming deals of its own. When gold falls, shares can go down, but poor industry conditions can also bring new opportunities for potentially lucrative financing deals that can be more advantageous for Franco-Nevada, Royal Gold, and other streaming companies.

There are many ways to invest in gold and which one is best for you depends on your particular goals. By knowing the differences between these popular gold investments, you'll be able to invest smarter and find the right way for your situation.

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