Once an investing idea becomes popular, Wall Street tends to jump on the bandwagon to give the public new methods of access to the latest fad. An explosion of new products follows, with financial institutions trying to cash in on all of the interest in the hot investment while it lasts.
Commodities have been one of those hot investment areas over the past several years, with substantial price increases in everything from crude oil to corn. In the world of metals, the price of gold has doubled over the past five years, and people are starting to greatly renew their interest in it as a result. In fact, among all of the various commodities, precious metals such as gold and silver probably offer the largest variety of ways for investors to take a position.
Metals, the old-fashioned way
Traditionally, typical investors could make substantial investments in precious metals in two ways. The first has been to buy shares of mining companies that extract precious metals, such as Newmont Mining
The other common way to gain exposure to precious metals has been through the use of futures contracts. With just a small initial margin investment, traders have been able to buy contracts controlling hundreds of ounces of gold or thousands of ounces of silver. At current levels, the main gold futures contracts that trade on the New York Mercantile Exchange represent about $65,000 in gold, while silver contracts represent physical metal worth about $70,000. Investors have to put up less than 10% of that amount, however, to purchase a contract. Although this extreme leverage means that you can lose more than your original investment if prices move against you, it also greatly enhances your profits when your investment goes well.
Just as with buying futures contracts, using miners as a proxy for metals has its advantages and disadvantages. On the plus side, some miners pay dividends on their shares, so your investment will earn income as well as potentially benefit from capital gains. On the other hand, mining-company stocks don't always move in lockstep with the price of metals. In particular, some mining companies use hedging strategies to lock in revenues for future deliveries of metals. While this gives miners a guaranteed price for their metal, it also means they give up the potential profits when metal prices rise.
New methods for buying metals
The rising popularity of exchange-traded funds has led to the creation of ETFs that track gold and silver prices. With shares of streetTracks Gold Trust
Even though these ETFs do nothing more than hold bullion, some people greatly prefer them to buying actual gold and silver bars or coins, in part because buying and selling physical metals is often more burdensome and costly, since most bullion dealers charge premiums to current prices so they can cover their overhead. Furthermore, once you take possession of precious metals, you have to find a secure way of storing them. With ETFs, on the other hand, you don't have to worry about any of the details and can instead focus on the spot price of the metals. What's more, ETF owners can buy and sell shares any time the stock markets are open, at relatively low commissions.
Sticking with the real thing
Some people who are interested in gold, however, don't consider it so much an investment as they do an insurance policy against the failure of the global monetary system. They look back to the abandonment of the gold standard as a fundamental event in economic history and foresee a time when paper money will no longer have value. Having served as a means of exchange for thousands of years, they believe, gold will reassert its role as the primary measure of value.
For these people, there's no substitute for owning actual precious metals. While shares of precious-metal ETFs and futures contracts do nominally represent a certain amount of metal, those who prefer holding the physical metals fear that these investments, too, would become worthless in a total collapse of the financial system. In addition, many bullion coins are quite attractive, and there's nothing like the feel and weight of gold in your hands as a measure of wealth.
As with any other hot investment area, you should tread carefully when considering precious metals for your portfolio. Whether you make or lose money, you can be certain that the firms that created these new investment vehicles for precious metals will end up ahead.
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Fool contributor Dan Caplinger is a closet numismatist, with several dozen bullion coins in his collection. He doesn't own shares of any of the companies or ETFs mentioned in this article. The Fool's disclosure policy is as good as gold.
