When it comes to investing in commodities, none is as controversial as gold.
Often derided as a barbarous relic, gold has nonetheless stood the test of time, anchoring the money supply of Western economies for most of recorded history. Although gold's importance has receded significantly since President Nixon removed the last vestiges of the gold standard in 1971, investors remain intrigued by the precious metal.
For investors considering a position in gold, there are many things to keep in mind. Below are four tips that can help make you a more informed gold investor.
Understand what factors influence gold prices
Gold is commodity unlike any other. The precious metal is unique in that it has almost no industrial uses -- outside of jewelry and some electrical demand, the gold market is mostly driven by investors.
For that reason, gold's price -- and the price of the stocks that depend upon it -- is largely a byproduct of currency strength: A stronger U.S. dollar tends to translate into lower gold prices, while a weaker dollar often benefits gold. The dollar itself is susceptible to a variety of factors, including monetary policy, the relative strength of the U.S. and global economies, and the trade deficit. These factors are complex and generally unpredictable, but if you're considering an investment in gold stocks, you should be aware of gold's relation to the currency markets.
Realize being a gold bug doesn't pay
As an inflation hedge, gold stocks can serve a key role in any balanced portfolio. However, too often investors become obsessed with gold, dedicating large swaths of their portfolio to the precious metal. It's so common that it's earned its own pejorative: gold bug.
Historically, gold has done a much better job holding its value than paper money over very long time periods, but it's suffered from the occasional sustained bear market. Worse, it offers no productivity, so while it may allow you to protect your capital, it's incapable of growing it.
Don't make this mistake. Limit your inflation risk with some gold exposure, but don't overdo it.
Properly evaluate gold miners
When it comes to adding gold to their portfolio, investors really have two different options to choose from. They can buy a gold-backed ETF, such as the SPDR Gold Trust (NYSEMKT:GLD), or they can indirectly invest in gold by purchasing the shares of a company whose financial success depends upon it.
These companies are, by and large, gold miners. In general, their financial performance depends upon the difference between the market price of gold and what it costs them to dig it out of the ground. Often, particularly during a bull market in gold, it's cheaper to mine gold than it is to purchase it. Investors interested in gold miners should know how to properly evaluate them and be aware of the risks.
Gold miners typically report two different numbers when it comes to their costs: cash costs and all-in sustaining costs. The latter is more useful, as it includes a number of costs associated with production that cash costs leave out. That figure generally gives you a good idea of what it actually costs a particular miner to dig an ounce of gold out of the ground.
Lower costs are obviously better, but there are other things that must be considered. Total production is important, as well as the location of their mines. Unfortunately, many gold mines are located in geographic regions that can be unstable. AngloGold Ashanti (NYSE:AU) has, in recent years, suffered under sustained labor strikes at its mines in South Africa.
Some gold miners mine other metals in addition to gold, which makes their share price susceptible to swings in other commodities. Some hedge their gold production, limiting their potential upside, while others remain unhedged. Goldcorp (NYSE:GG), for example, is committed to remaining entirely unhedged, which enhances its risk profile -- it is particularly susceptible to falling gold prices -- but also offers greater potential returns when gold prices are strong.
Know the tax ramifications
Finally, it's worth pointing out that investing in gold can bring a greater degree of complexity to your tax returns.
While long-term capital gains taxes are currently capped at 15% for most investors, the IRS treats gold bullion differently than other investments. For tax purposes, it's considered a collectible, meaning that it doesn't qualify for the same tax rates. In fact, taxes on selling gold bars may be as high as 28%.
What does that have to do with gold stocks? Unfortunately, the same holds true for gold-backed ETFs, including the SPDR Gold Trust. The higher taxes may not be enough to discourage gold investing outright, but it's certainly worth keeping in mind.