Investors who are interested in gold-based investments essentially have three choices, says Kevin DeMeritt, founder and chairman of Los Angeles-based gold and precious metals firm Lear Capital.
“You can hold a gold stock; an exchange-traded fund, which is just backed by physical gold — or you can be in complete control of your metals and hold them physically within an IRA,” DeMeritt says. “With an exchange-traded fund, a lot of that metal is held in a different country. But when you’re holding it physically, it’s yours.” (To that end, the metals are actually held in a depository, not physically by an investor.)
With a relatively limited supply — estimated to be around 50,000 metric tons in global mine reserves — and numerous practical uses, gold has historically been viewed as a very valuable asset.
In addition to ornamental utilizations like jewelry, gold, which is a highly efficient conductor, has been incorporated into electronic items, including computers, and is used in glassmaking and dentistry. The COVID-19 pandemic also heightened interest relating to the antimicrobial aspects gold and some other materials possess.
Gold’s physical applications, though, are just part of its appeal. Although the U.S. began moving away from a gold standard in the 1930s and today, along with other countries, does not back its currency with gold, a number of nations, according to Kevin DeMeritt, still keep sizable reserves of gold on hand.
“Russia has completely eliminated all of their reserves of U.S. Treasuries, and what did they replace it with?” Kevin DeMeritt says. “Gold. They’ve doubled the amount of gold that they’ve held in reserve at their central bank. Same thing with China — they’ve sold off U.S. Treasuries; they’ve been replacing it with gold. Because we’re printing up all this money, they believe holding a Treasury [security] that pays 3%, when inflation is 6%, just makes absolutely no sense. They’re paying us 3% to hold our debt.”
Globally, governments’ emphasis on maintaining gold reserves has contributed to the overall demand for the precious metal, and has helped gold maintain and at times, even increase in value during challenging economic periods.
Lately, we’ve seen an uptick in governments’ gold activity. As of December, a World Gold Council update stated that after reduced activity in early 2022, central banks had returned to a pattern of regularly buying gold, with the largest purchase made by the People’s Bank of China.
Due to inflation and global political uncertainty, central banks’ demand for gold reached a record level in 2022, with particular interest from banks in emerging markets like Turkey and China.
A Formidable Asset Class Contender
For years, financial advisers have been more likely to discuss investing in exchange-traded funds — which involve purchasing a piece of paper that’s typically backed by about 80-90% in physical gold — with clients, according to Kevin DeMeritt.
Physical precious metal asset-based investments, though, can offer several advantages — including reducing some of the risk that’s inherently involved in investing in an entity over which you have no control.
Unlike physical gold assets you directly control, with an exchange-traded fund, gold that’s held in banks located in other countries can be subject to any issues the financial institutions experience.
“If something goes wrong with [the] bank, you have a problem,” Kevin DeMeritt states. “How do I get the gold back over here? In most of [the] documents for exchange-traded funds, it says, ‘If there is an issue, we can give you a like-kind asset.’ I don’t know anything that’s like gold, so I don’t know what other asset you’re going to give to me. Some people [say], ‘They’re just going to give you another stock — maybe another exchange-traded fund.’ It isn’t really the metals they’re talking about; it’s just another piece of paper.”
Gold mining company-related stocks can also involve additional considerations.
“Things can affect that stock that have nothing to do with the price of gold,” Kevin DeMeritt says. “They could bribe some government official because it’s pretty hard to dig a hole in the ground for gold without tons of rules and regulations, and then that comes out — and the stock potentially crashes.”
The Lear Capital founder says various other business decisions can also significantly impact the stock’s worth.
“You have what we call third-party risks that you don’t have with physical gold,” Kevin DeMeritt says. “You’ve got the risk of the CEO hedging gold one way and it goes the other way, and appreciation you thought you were going to get was right but went the wrong way. The company could take on a little bit too much debt, interest rates go up, their earnings crash because they have to pay all this interest — and now I’m paying for it because I own the gold stock, as opposed to the actual gold.”
Gold’s Promising Value Proposition
The potential protection gold can provide can be enticing to investors who are looking to offset losses other investments may incur.
A number of asset classes struggled, for example, during and after the 2007 to 2009 recession — such as housing prices, which fell 33%, and commercial mortgage real estate investment trusts, which posted returns of minus 74.8%.
Gold’s value, however, rose significantly between 2008 and 2012, ultimately escalating 101.1%. Since 2001, gold’s value has actually grown 566%, according to Lear Capital data.
In an examination of gold prices before and after the 2007 to 2009 recession, the Bureau of Labor Statistics stated: “In times of either a crisis or inflation, many investors turn to gold to protect their principal.”
Despite some fluctuations, gold-related investments have generally provided positive returns during the past 20 years — on average, 0.44% in 2022. Typically, Lear Capital recommends investors allocate no more than 20% of their portfolio to precious metals like gold.
“It’s a great diversification tool,” Kevin DeMeritt says. “Gold has outperformed the stock market since 2000. If you would’ve placed 80% of $100,000 in stocks [back then] and 20% in gold, you’d have picked up an extra $60,000, [compared to investing] $100,000 in stocks. With inflation and [a] recession looming, people should consider precious metals as a hedge against some of that economic uncertainty.”
[EB1]between 2002 to 2022
[EB2]This quote is the combination of parts of three comments from his interviews; the third sentence has been reworded to make it shorter — we may be able to remove the brackets, if the client is OK with it.
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