Manie Marais: Smart ways to invest in gold – A guide for investors

If you'd invested $10,000 in gold on January 3, 2000, it would have grown to $95,300 today, outperforming both the S&P 500 and AngloGold returns. With gold's appeal as a resilient asset reaching historic highs, investors are eyeing options like physical gold, gold-backed ETFs, and mining shares. This article examines each, focusing on cost-effective ETFs and balanced mining funds for optimal risk-adjusted returns in a gold investment strategy.

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By Manie Marais

Introduction

Which option would you prefer today: Investing $10,000 in Gold, the S&P 500 or AngloGold on 3 January 2000? 

Surprising outcome: The gold investment would have soared to approximately $95,300 today, while the S&P 500 returned $62,300. AngloGold would have only yielded $17,800! Who would have guessed gold would outperform the S&P 500 Total Return by $33,000! *Assumption: all investment returns reinvested.

With gold prices reaching historic highs, global investors are showing renewed interest in this enduring asset class. For millennia, gold has served as both a symbol of wealth and a reliable store of value, offering unique investment characteristics that distinguish it from other assets.

I shall explore various gold investment strategies, focusing on practical approaches while excluding more speculative instruments like futures and options.

Investment Options

1. Physical Gold

Investment options for physical gold include three main categories: Gold Bullion, which consists of gold bars, ingots or Gold Coins which include popular options like the American Gold Eagle, South African Krugerrand, and Canadian Maple Leaf.

Advantages of physical gold ownership include direct ownership without counterparty risk, physical security, high liquidity, portability, and independence from the financial system. However, there are disadvantages, such as storage and insurance costs, security concerns, high transaction costs, and premium pricing above the spot price of gold.

While physical gold offers compelling advantages as a tangible, portable asset that provides direct ownership without counterparty risk, remains highly liquid across markets, and operates independently of the financial system, investors must weigh these benefits against significant drawbacks including storage and insurance costs, security concerns in high-risk areas, substantial transaction costs with typical spreads of 3-8% and the need for authentication when buying or selling.

2. Gold ETFs (Physical-Backed)

Gold Exchange-Traded Funds (ETFs) have revolutionized how investors access the precious metals market, offering a sophisticated bridge between traditional securities trading and gold investment. These financial instruments, which track the price of gold and are backed by physical bullion, have emerged as a cornerstone of modern gold investment strategy.

The appeal of gold ETFs lies in their elegant simplicity and accessibility. Investors can seamlessly integrate gold exposure into their portfolios through standard brokerage accounts, trading shares with the same ease and cost as common stocks. 

One of the most compelling advantages of gold ETFs is their cost-effective structure. These funds typically operate with remarkably low expense ratios, often a fraction of a percent annually. Transaction costs are minimal, comparing favourably to the substantial premiums and fees associated with buying and selling physical gold. The elimination of storage and insurance concerns further enhances their appeal – the fund assumes these responsibilities, maintaining secure vault facilities and comprehensive insurance coverage on behalf of shareholders.

However, investors should understand the fundamental nature of their investment in gold ETFs. Unlike physical gold ownership, ETF shares represent an indirect claim on gold rather than direct possession of the metal. While this distinction may seem subtle, it introduces an element of counterparty risk. This risk is generally considered minimal. 

For retail investors, they offer a practical solution to the challenges of gold investment, balancing security and accessibility with cost-effectiveness.

In essence, gold ETFs represent a modern evolution in precious metals investment, offering a refined balance of convenience, cost-effectiveness and market access. 

3. Gold Mining Shares

Gold mining investments offer compelling opportunities for investors seeking exposure to the precious metals market, with two primary vehicles: individual mining stocks and mining-focused ETFs. Let's explore these options in detail.

Gold mining shares represent a sophisticated approach to gold investment, offering investors an indirect path to precious metals while capturing the upside potential of well-managed mining operations. These investments are particularly attractive due to their operational leverage, where even modest increases in gold prices can lead to outsized gains in profitability. Many mining companies also provide regular dividend payments, creating an additional income stream that physical gold cannot match.

Skilled management teams can drive value through strategic expansion, technological innovation, and efficient operations. However, these opportunities come with notable risks. Mining operations can face disruptions from various sources, including lbour disputes, equipment failures, weather hazards and regulatory changes. Political instability in host countries can also impact operations.

4. Gold Mining ETFs

Gold mining ETFs present an alternative approach, offering investors a diversified portfolio of mining companies under professional management. These funds have gained popularity among investors seeking broad industry exposure without the complexities of selecting individual stocks. ETF portfolios can range from major established miners to junior exploration companies, allowing investors to match their risk tolerance with their investment goals.

For sophisticated investors, a custom portfolio approach has shown promise. Equal-weighted portfolios of carefully selected mining stocks have demonstrated the potential to outperform standard ETF offerings on a risk-adjusted basis. However, this strategy demands active management and continuous monitoring to maintain its effectiveness.

The choice between individual stocks and ETFs ultimately depends on an investor's goals, risk tolerance, and investment capacity. While individual stocks offer the highest potential returns and direct exposure to company success, ETFs provide a more manageable, diversified approach suitable for long-term investors seeking sector exposure with reduced company-specific risk. Both options merit consideration as part of a well-planned precious metals investmentstrategy.

Comparison of the different investment options

Firstly, let us compare Gold ETFs with Gold Miners ETFs over several years (gold bullion should follow gold ETFs but is not considered here for the high transactional costs as well as the storage risks).

Table 1: Physical Gold ETF vs. Gold Miners ETFs (in USD)

The performance analysis of mining ETFs has revealed interesting patterns. Funds with more concentrated portfolios, typically holding 30-35 companies, have generally outperformed their more diversified counterparts. ETFs with higher concentrations in their top ten holdings – often exceeding 70% of the portfolio – have shown particularly strong returns. This suggests that focused exposure to industry leaders may offer advantages over broader market participation.

From Table 1 it follows that the physical gold ETF (Ticker: GLD) performs well against the Gold Miners ETFs but notably the fewer gold stocks in the ETF the better the performance. Gold miner ETFs like AUCO the best performer over almost all periods had only 33 miners in the portfolio. In second place RING with 35 miners. Both are the only ETFs where the top 10 miners represent more than 70% of the ETF.

Table 2: Top Gold Miners performance (in USD)

The table highlights the inherent risks of investing in individual gold mining companies, emphasizing the extreme volatility that can affect even top performers. For example, while Gold Fields emerged as one of the best performers over a five-year period, it simultaneously became one of the worst performers over the last year. This stark contrast underscores the difficulty in predicting which mining company will deliver consistent returns, as performance is highly variable and influenced by numerous factors.

Even historically strong performers are not immune to volatility. AngloGold Ashanti, for instance, experienced several stellar years, but in July 2022, its price was roughly the same as it had been in early 2001—over two decades earlier. Since 2022, the share price was on a tear. This pattern demonstrates that long-term investments in mining companies do not always guarantee growth, as the sector is heavily affected by fluctuating gold prices, operational setbacks, and market conditions.

Recent events also illustrate how quickly market sentiment can shift. For example, Newmont, one of the largest and most stable gold miners, missed its earnings forecast earlier this week. The result was a sharp drop, with the company's value falling by over 18% between October 23 and October 25. Such dramatic declines in response to short-term earnings misses highlight the sensitivity of mining stocks to financial performance and market expectations, making them a risky choice for investors seeking stability. My own two choices were Barrick Gold and Newmont!

In conclusion, while investing in individual gold miners can offer high rewards, it carries significant risks due to the sector's exposure to commodity price swings, operational challenges, and geopolitical factors. For investors, these risks reinforce the importance of careful diversification and consideration of broader factors influencing the mining industry.

Another option would be to form one's own ETF with the top 8 gold miners as constituents with each having a 12.5% weight. The result is below:

Table 3: Tailored equal-weight ETF (in USD)

If we now compare the best Miners ETF against the Physical gold ETF as well as our own Tailored equal-weight ETF the results are as follows.

Table 4: Tailored equal-weight ETF vs. Gold Miners ETF vs. Physical Gold ETF (in USD)

Conclusion

The enduring value of gold as a strategic investment asset continues to be validated, particularly during periods of economic turbulence and market uncertainty. The crucial decision facing investors isn't merely whether to invest in gold, but rather how to optimize their exposure to this precious metal.

The evidence suggests that physically backed Gold ETFs represent the foundation of a prudent gold investment strategy for most investors. They offer a compelling combination of cost efficiency, security and liquidity. It positions Gold ETFs as an excellent core holding for investors seeking stable gold exposure.

However, the landscape of gold mining investments presents a more nuanced picture. While mining stocks and their ETFs offer potential for amplified returns, they come with considerable risks that demand careful consideration. The operational, geographical, and financial challenges facing mining companies can create significant volatility, making individual stock selection particularly challenging for almost all investors.

A balanced approach, combining physically backed Gold ETFs with selective exposure to mining ETFs, appears to offer an optimal risk-adjusted strategy. Particularly noteworthy are the concentrated mining ETFs, which focus on a smaller number of well-established miners. These focused funds have demonstrated superior performance compared to their broadly diversified counterparts, suggesting that quality and selectivity trump breadth in the mining sector.

While constructing a custom portfolio of major mining stocks might yield higher returns, this approach demands active management, ongoing monitoring, and careful consideration of tax implications. For most investors, the time and expertise required for such active management may outweigh the potential benefits, especially when considering the sophisticated risk management already embedded in well-managed ETFs.

My take on gold investment is that a combination of Gold ETFs and Gold Mining ETFs is the optimal solution for exposure to gold.

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*Manie Marais is Director of finmar Asset Management (Pty) Ltd