Gold has played an important role in human history for thousands of years due to its rarity, use in trade, and as a store of wealth. Today, investors still view gold as a potential way to help protect wealth. But the question arises: how does the modern gold market work? This overview explains the nuances of this resource, ways to invest in gold, and how it may fit into a diversified portfolio.
Modern Gold Market – What Do You Need to Know?
Unlike many commodities, gold isn’t used up. In fact, almost all the gold ever mined still exists. Roughly 220,000 tonnes have been mined throughout history, and annual production adds only about 1% more. Due to high fixed costs and long lead times to open new mines, the gold supply grows slowly and predictably.
The market is largely driven by trading activity centered in London and New York City, with Switzerland serving as the main refining hub. Because gold doesn’t get consumed, its price is driven less by supply and demand for physical use and more by investor activity. Essentially, buyers and sellers determine price based on their desire to acquire it.
The main buyers of gold are central banks, exchange-traded funds (ETFs), institutional traders, and households (especially those in emerging markets). The first three buyers are the main drivers of the price of gold. Their activities are driven by policy or macro views and tend to be price insensitive. Households are more opportunistic in their buying and selling, and their sensitivity to prices can lead to activity that runs counter to other buyers. Affordability, or lack thereof, plays a big part in households’ role in the gold market.
Where Do Golden Investments Shine?
The two primary ways for individual investors to gain exposure to gold prices are physical gold and gold ETFs. Physical gold is the direct ownership of bars and coins. This tangible ownership removes counter-party risk, but comes with storage and security concerns, as well as insurance costs. Physical buying and selling of gold also face liquidity issues and uncertain bid/ask spreads (or the difference between the price to buy and sell).
In times of stress or large swings in prices, the bid/ask for individual investors to the spot price of physical gold usually widens. During these times, investors can also face limited liquidity, particularly when trying to sell. ETFs offer easy trading and liquidity. They track the price of gold, but investors own shares of a fund, not the gold itself, and generally cannot redeem shares for actual bullion. Finally, ETFs charge expense ratios and involve counterparty risk. Investors must understand how the ETF is structured and operates before investing.
How Can Gold Fit Into Portfolios?
Gold can serve multiple purposes in a portfolio, depending on the investor’s goals. During long periods, gold has historically helped protect purchasing power against inflation. However, its price is influenced more by interest rates, the U.S. dollar, and central bank buying over shorter periods of time.
In addition, gold can act as an effective hedge in shorter timeframes against geopolitical risk and times of financial stress. These benefits must be balanced against the fact that gold does not produce income, and that the gold market is a small fraction of the size of the global stock and bond markets (meaning it can experience very large price swings). In certain market environments, gold has lagged behind other investments for extended durations.
Taxes are another key factor for investments in gold. The IRS classifies gold (and physically-backed gold ETFs) as “collectibles” under Internal Revenue Code (IRC) Section 1(h). Under this code section, collectibles are taxed as ordinary income at the taxpayer’s marginal tax rate (up to 37%). For investments in gold classified as long term (held more than one year), the federal marginal rate applicable to the gain associated with the collectible is capped at a 28% rate. These long-term gain tax rates for collectibles are much higher than the long-term capital gain tax rates that apply to stocks and bonds. This can make gold significantly less tax‑efficient than other investments, so it’s important to plan carefully and consult a tax advisor.
What Are Key Considerations for Going Gold?
For investors considering gold, it’s crucial to clarify why they want exposure and how they prefer to own it: whether it be physically or through ETFs. Care needs to be taken to reduce the potential impact of taxes on any sales. A reasonable allocation is typically 2% to 10% of a diversified portfolio. Consider that while gold can diversify a portfolio and act as a potential hedge, it is not a “safe” asset in the sense of being stable or predictable. Thus, physical gold can be difficult to sell during turbulent times as prices move sharply.
How Forvis Mazars Can Help
However, gold can play a useful role in long-term wealth management when approached with mindful and intentional planning. The team at Forvis Mazars Private Client can help manage complex financial matters so you can pursue what’s important to you. From wealth management to consultative tax and more, our professionals are ready to assist with your financial strategy. For more information, please reach out to the team at Forvis Mazars Private Client.
Forvis Mazars Private Client services may include investment advisory services provided by Forvis Mazars Wealth Advisors, LLC, an SEC-registered investment adviser, and/or accounting, tax, and related solutions provided by Forvis Mazars, LLP. The information contained herein should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies mentioned herein, may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax or other strategy mentioned herein. The information herein is believed to be accurate as of the time it is presented and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.