How to buy gold for diversification

I’ve alluded to this previously: I buy a bit of gold as part of my campaign plan. This isn’t a popular suggestion with the financial independence community so I’ll explain why.

This isn’t just an attraction to shiny things that’s playing out. Gold has performed remarkably well historically. In the book How to own the world (incidentally, one of my favourite financial independence/ investing books of all time), Andrew Craig makes a compelling case for buying physical gold as part of a regular investment plan. The website portfoliocharts.com, which analyses the performance of portfolio balances, has even identified gold as being one of the key components of its “golden butterfly” portfolio.

This post is about how a regular UK investor might go about buying and selling gold.

As with everything: this is not financial advice and is intended for education. Just because it’s a plan I like, doesn’t mean it’s a good plan for you. Do your research and don’t trust some random on the internet!

Why I buy gold

Diversification

Apart from being nice to hold (it is, by the way!), gold doesn’t usually peak and trough in price at the same time as shares. Usually, when people panic about the future of the stock market and inflation looms, people run to gold. That makes it a good choice for diversification: if shares are down, gold should be up. I want to control when I retire from the workforce. This means that I need lots of diversification options if I don’t want to be at the mercy of stock markets.

Buy gold – own inflation

Gold is a commodity. Our monetary system is “fiat” (from the Latin for “faithful”), so it has exactly as much value as there is demand for it. It’s logical, then, that with more money being printed there’s more supply. Supply and demand determine relative values, so it’s logical that the continuous creation of money by central banks and overdraft debts and the like will mean that supply grows against demand. That’s right, your cash becomes worth less over time.

Fun fact: when our currency was measured in gold, one ounce of shiny cost £4.25 in 1914. It’s around £1,285 at time of writing for the same ounce. That’s inflation in action for you.

Conversely, there’s only so much gold in the world at any one time. Not only is it rare, it’s increasing in demand. Historically, we’ve used it for money and it’s still a reserve currency used between nations when one country doesn’t trust another to pay its debts in cash. In Asia, demand for gold as a personal investment is rising.

It stands to logic that when you have a decrease in value of one asset (£GBP) and an increase in another (gold), you’ll need to pay more of the first to get the same amount of the second that you bought before. Basically, the gold price increases relative to cash over time. Andrew Craig explains this very well in his book and suggests using gold to “own inflation”.

Here’s a video from the World Gold Council on why people might invest in gold generally. I don’t agree with all of the people in it, but it’s an interesting watch.

Options for buying gold in the UK

If you want to buy gold in the UK, there are a few options. Each option comes with a benefit and an unfortunate downside. Here’s a brief summary through some options.

Option 1: Buy a gold ETC or gold miner ETF

ETFs (and their commodity equivalents, Exchange Traded Commodities) allow you to buy gold through a stocks and shares platform. Yep, it’s possible to own gold through an ISA or SIPP if you own gold this way.

You don’t own the gold directly through this method. Instead, you buy a share or unit in a fund, and the fund owns the gold. You’re basically owning the gold indirectly.

Good things about ETFs/ ETCs

This is convenient because you can sell it whenever markets are open and you generally don’t pay much premium (the difference between the gold price and the cost of getting the physical gold). You buy in, markets do their thing, you sell when you want the cash. Simple!

Downsides of buying gold on the stock market

Unfortunately, the biggest downside here is that many gold ETFs and ETCs are actually based on paper trading. That’s right: you think you’re buying 14kg of 24-carat shiny, but you’re actually buying 10kg and the promise that 4kg will turn up in the future. [I made those numbers up but the principle is scarily close to the truth!] The classic saying with gold and silver is that “if you don’t hold it, you don’t own it”. Why is this a problem?

If rumours are true, there have been in the past 293 claims for 1 oz of gold on paper than there are physical ounces of gold available in the market. Now, I couldn’t verify this source as it’s from a site that wants to sell you precious metals, but it’s not the only place I’ve heard similar rumours. The point is that ETFs and ETCs can sometimes be made up of futures contracts instead of big lumps of metal. That’s all well and good until there’s suddenly a panic surge for gold and your ETF is left holding a useless bit of paper when the music stops.

You can minimise this risk by buying into a “physical gold ETF” (or ETC). If this route is one you want to follow, make sure to read into the investing documents and scrutinise the fine print to see what you’re actually buying.

You could buy into ETFs that effectively buy shares in gold miners. Usually, you’d expect the share price of a gold miner to increase or decrease with the price of gold. It’s not a perfect link, however, and the prices don’t always move in sync with each other.

Option 2: buy a vaulted gold scheme

With something as old an investment as gold, you get other schemes for investment that pre-date modern stock exchanges. The classic investment scheme is to buy gold and put it into a vault somewhere. Interestingly, this is still a thing – although modern technology makes it a lot more convenient for you hoarders out there.

On a modern scheme, you pay into a company that buys physical bars of gold (usually “London bullion market good delivery bars” or wording to that effect) and stores it in their vault for you. They charge you a storage fee, which is how they make their money, but you get their secure facilities.

There are a few schemes out there if this is something you want to research. The main thing to look for is that there are effectively two types of scheme: “allocated” and “unallocated”. Bullion gold bars tend to come in at 14kg and it’s highly unlikely that as a reader of this blog you’ll have enough cash to throw down on a whole 14kg good delivery bar of metal. This means that when you buy into a vaulted scheme, you’re probably buying a share of a bar, like buying equity in your house against a mortgage. Now, if it’s an allocated scheme, your money is aligned to the equity in a specific bar. It’s completely auditable and traceable, and if the vaulting company goes bust you’ll probably have your money protected by trust laws; a legal technicality that’s a little beyond the scope of this piece. However, if it’s unallocated, your money is just in a big pool of client money. It’s possible that trust laws might protect you if the company goes under, but it’s a lot less certain as your money is just in a pool of assets.

Benefits of buying gold in a vaulted scheme

Again, convenience is key here. You never have to take delivery. You also get the benefit of industry standard security that you definitely couldn’t fit into your own home. Some schemes, like Bullionvault, allow you to have the gold delivered to your home/ another provider if a) you own whole chunks and b) you’ve had enough of them. It’s also phenomenally easy to sell the gold when you need the cash, as most schemes simply buy the gold off you when you need it or run their own secondary market. It’s possible to buy this direct from the Royal Mint who have a DigiGold service (formerly called Signature Gold).

Downsides of buying gold in someone else’s vault

It should be no surprise that providing a vaulted service will come at a cost to customers. This means that you will be paying fees onto account, which vary from platform to platform. There’s also the counterparty risk, which means the risk of the storage company defrauding you. That said, if you believe that the Royal Mint are lying to you about a small amount of gold after a centuries of being a state-sponsored institution with millions in metal at their disposal and a global reputation to maintain, maybe investing in general isn’t for you.

Option 3: buy tokenised crypto gold

Thanks to the wonders of the blockchain and modern technology, you can buy stablecoins that are based on gold.

Is a stablecoin that’s backed up by gold more stable than our own £ GBP? A debate for another time, perhaps.

Examples of this are Tether Gold, Paxos Gold and even the Perth Mint Gold Token. To be fair, these are variations on the vaulted gold theme. However, unlike vaulted gold, you don’t have a fee for storage and you can sell the crypto at any time on a blockchain exchange.

What’s brilliant about buying blockchain gold

Easily transferable, reasonably liquid, can even be used to earn cryptocurrency interest. This means that it’s the only form of gold that you can still get paid to own, which is unique amongst the options available.

What sucks about being servant to the blockchain

As with all options, there are bits of this scheme that suck. For instance, there’s the risk that a particular token isn’t popular enough to trade on a particular exchange – if there aren’t enough customers, it’s not getting sold when you want to cash out. There’s also the fact that if you don’t have an exact amount of tokens to cash in for a whole ounce of gold then you won’t get all your cash back from the issuing company if you want to withdraw your gold from the scheme. Finally, there’s the possibility that the blockchain that the token is hosted on stops being serviced as a network, which is unlikely in the next 10 years but technology moves fast.

Option 4: buy physical gold

Finally, the most obvious solution: just buy physical gold.

Strange as it sounds, people still buy physical gold as an investment. When I mentioned the Andrew Craig book earlier, I forgot to mention that he recommends buying physical gold in the book, for the average investor.

Thanks to the power of the internet, there are a few reputable places to buy gold, and a few less common but occasionally profitable places to buy and sell from.

This post is long enough already so I’m going to summarise really briefly on buying physical gold bullion, however there’s more detail on buying and selling previous metals in my post on trading physical silver bullion as a side hustle. Most of the lingo and the principles are the same, even if the metals are different.

Physical gold is VAT exempt and – even better – British physical gold bullion coins are exempt from capital gains tax. That’s right: if you build up a pile of gold to go alongside your shares and bonds, you can sell them whenever you want and the tax man won’t trouble you. That’s useful if you have shares that are outside of an ISA or SIPP that would count towards your annual capital gains tax limits.

If you decide that physical gold is for you, you can do a lot worse than buy gold sovereigns. These coins are actually the original £1 coin from back in the days when our money was gold and silver. They’re very easily sold, come in conveniently small sizes and have the lowest premium above the spot price of gold. There are smaller coins, larger coins and bars that do a similar thing, but the low premium price makes gold sovereigns a solid choice.

A Royal Mint gold sovereign. The coin is currently alloyed with copper, hence the tint, but older coins are more yellow. Still 22-carat gold in either case.

Where to buy gold bullion

There are a few places to buy physical gold, however it’s worth noting that you need to shop around for the best price at any time. I’ve noticed that Facebook groups tend to be cheaper to buy from when the price of gold is on a high, but when the price of gold is in decline it’s usually more expensive to buy from private sellers. This is probably because the professional websites update their prices in short cycles, to track the live gold prices.

I’ve used the same Facebook groups that I’ve bought silver from to buy gold coins. I’ve also used Bullion by Post, with good results. Chards, ATS Bullion and other main dealer websites are worth checking out, as different sites have different offers. You can buy direct from the Royal Mint but I’ve noticed that dealers are usually cheaper.

[In fact, if you use Bullion By Post through my affiliate link, we both get a silver coin if you spend an amount of cash (I forget how much). However, don’t use the link unless you’ve already decided to buy from them. Make sure you’re well researched and don’t trust some random on the internet with your financial independence.]

Why physical gold is awesome

The best thing about physical gold is that you can hold it. When you’ve got actual possession, it’s an investment with zero counterparty risk. It doesn’t matter if any companies go bust, as long as you have the coins or bars you’ve got something that isn’t going to go missing.

Why physical gold sucks

Unfortunately, an investment with zero counterparty risk comes with a big new problem: storage. I hear stories of people sawing up floorboards to hide safes and lockboxes in their homes, but that doesn’t really stop the risk of fire or that someone breaks into your house and rips out the safe. You could get around that by renting a safe and insured storage box or space in a vault but the storage fees are quite high if you only have small amounts to deposit. Ultimately, that’s an issue for you to solve, and for all the obvious reasons I’m not going to say how I’ve resolved it for the small amount I hold.

It’s also a pain to liquidate. You can sell back to a dealer or sell privately (see the silver trading post) but it takes time.

Why gold isn’t the best investment ever

So far I’ve covered why I buy gold in my portfolio and how you can buy it in the UK. What I haven’t covered yet is one very important thing: the risk of investing in gold at all.

All investments hold risk. All of them, even cash. In gold’s case, the risk is that the price is fairly volatile: it generally goes up over time, but it peaks and troughs just like shares. It’s also completely unproductive (except, arguably, tokenised crypto gold that’s earning interest somehow). That means that if it falls out of fashion, you’re not getting dividends or any other passive income from it – you just have to hold it and hope/wait for it to grow in value. This might take a while.

I’ve heard arguments that gold is only valuable because of the memory of it being used for money. That may or may not be true, but as I’m hoping you’ve seen in my financial independence campaign plan for 2021 I strongly believe in diversification. That way, I’m minimising my risk of any asset underperforming. So, if the world decides that gold is dead, screw it – I guess I’ll just delay my financial independence achievement date for a few years while I top up the portfolio with something else!

How I use gold

Gold is a great diversification tool, but it doesn’t produce anything and I’m not yet convinced on the trustworthiness of crypto tokenised gold. It forms about 10% of my portfolio overall in various ways, which seems like a fair amount of exposure without committing too much.

At the moment, I’ve bought physical gold as my main exposure to it. If we go ahead with our potential end game of heading out to live on a boat and bimble around the world, I’m probably going to switch to a digital gold solution, like the Royal Mint DigiGold service. Boats are kind of easy to rob, and I don’t like the idea that if I have to abandon ship I lose some of the funds I need to buy a new boat with!

Hopefully, this article/post has given you some food for thought. Whether you like it or loathe it, gold has been a reasonably well-performing asset for a long time and I believe that any investor should at least consider it, even if they decide not to include it in a portfolio.