Gold: to have and to hold

David Stevenson examines different ways investors can buy the precious metal

August 29, 2012

Trading volumes for gold remain at unprecedented levels, and both gold and silver prices have been boosted significantly by speculation over a further round of central bank stimulus in the US (see 'Golden opportunity', IC, 24 Aug 2012). If you believe that physical gold's time has come, you've got two main choices - a fund or physical gold.

Gold funds

The most popular route is to buy into a fund that invests in allocated, physical, 400 ounce gold bullion bars. These funds are usually operated by fund managers from the exchange-traded fund sector and include ETF Securities in the UK and State Street (SPDR) in the US. In total, there's well over $128bn (£81.06bn) invested in these gold trackers globally. These 'physical gold funds' are probably the most convenient way of owning physical gold in bullion form as you don't have to worry about storage or insurance and trading can be done online in a matter of seconds.

But these funds are not always the cheapest option (the average total expense ratio is usually between 0.25 and 0.40 per cent of the value of assets in the fund) and nor do they give you a chance to get your hands on actual gold bars - only institutions can swap their fund share certificates for allocated bars of gold delivered to a LBMA storage vault.

Gold coin prices

Gold Bars

(All 24 carat and from London Good Delivery Manufacturers) - Premiums quoted for small quantities - premiums may change according to supply and demand.

■ Kilo Bar 2.5 per cent premium - current cost £33,215

■ 500g Bar 3.5 per cent premium - current cost £16,775

■ 100g Bar 4.5 per cent premium - current cost £3,380

■ 50g Bar 5.5 per cent premium - current cost £1,710

■ 1oz Bar 6 per cent premium - current cost £1,068

Gold coins

■ 1oz South African Krugerrand 22 carat 5 per cent premium - current cost £1,058

■ 1oz UK Britannia 22 carat 7 per cent premium - current cost £1,078

■ 1oz Canadian maple 24 carat 7 per cent premium - current cost £1,078

■ 1oz Australian nugget 24 carat 7 per cent premium - current cost £1,078

■ 1oz US Eagle 22 carat 7 per cent premium - current cost £1,078

■ UK Gold Bullion Sovereign (dated 1887-1982) 0.2354 troy ounce 22 carat - 8 per cent premium - current cost £256

Source ATS Bullion

Gold bars

If you prefer the idea of holding real gold, you can use one of the growing number of allocated storage providers such as BullionVault (backed by the Rothschild family as well the World Gold Council) and GoldMoney to buy, sell and store bars of gold. These relative newcomers to the gold market offer what's called 'allocated' and very secure storage at a relatively low cost - BullionVault charges as little as 0.12 per cent per year of the value of your gold assets for storage costs (0.18 per cent per year at rival GoldMoney), plus a small monthly charge for insurance - dealing costs start at 0.80 per cent of the value of the gold and drop to as low as 0.40 per cent for $30,000 or more of gold. Crucially, this physical gold in storage is also inspected on a daily basis with both main providers. Investors can also arrange next-day physical delivery of their gold bars.

Coins and small bars

Investors can also very easily buy smaller amounts of gold, usually either coins such as sovereigns and krugerrands or small kilo bars. Gold coins can easily be bought via a bullion dealer such as ATS, or Bairds, and can then be stored at home, giving private investors the ultimate in portability.

There is an enormous choice of gold coins, with most major developed world nations offering their own coinage, but perhaps the most familiar is the South African Krugerrand (first mass produced in 1970). According to Sandra Conway, managing director of ATS Bullion: "The Krugerrand is a very popular coin, mainly because it trades at the lowest premium of all the 1oz coins and so tends to be the best value. The UK 1oz Britannia and the gold sovereign (an old pound coin, weighing 0.23 troy oz) are both popular, particularly for investors where capital gains tax is an issue. Sovereigns tend to appeal to smaller investors, as they are more affordable."

Sovereigns minted after 1837 are technically a tender coin and can thus be bought and sold free of capital gains tax. Investors should note that buying investment-grade gold bullion generally is free from both stamp duty and VAT in the UK.

Gold coins are typically issued at prices that are not fixed but based on the prevailing value of their fine gold content - they are usually also mass produced in large quantities, and are frequently legal tender in their issue country. Crucially they typically have no coin collecting value - their market value is almost always directly related to the value of the gold in the coin, based in turn on the number of troy ounces.

But this direct ownership of small units of gold introduces significant extra cost - small units of gold carry a premium to pay for dealing costs and the extra cost of refining larger bars down into small coins. In simple terms the premium charged by the dealer will increase as the fractional coin weight declines, ie a 1oz coin will have a smaller premium than a 1/20th fractional.

This premium can easily amount to more than 8 per cent for even the most popular coins - Krugerrands usually offer the smallest premium at around 5 per cent, while most competitor coins have a premium of around 8 per cent, although the premium can rise to as much as 18 per cent for small, 10 gram bars of gold. Investors also need to factor in extra insurance costs for home storage as well as an additional spread of as much as 1 per cent when they attempt to sell their coins back to a dealer.

Investors in physical gold also need to understand the ins and outs of the gold bullion market, which comes complete with its own peculiar language and strict rules. Allocation matters above everything else. If you own gold through a fund you need to make sure that your gold is physically segregated from the wider stock of gold and also 'allocated' in the fund's name - in turn a physical gold fund needs to be 100 per cent backed by actual gold held in a vault.

The most widely held forms of allocated gold, by contrast, are stored by a separate custodian (HSBC for instance acts as custodian for ETF Securities), with a separate trustee managing the segregated assets on behalf of the fund investors. Insolvency by any party in this chain of custodian-trustee-fund issuer should not have any substantive impact on the value of your allocated gold.

For most investors the next most important consideration has to be whether the bullion in your ownership is what's called LBMA Good Delivery. LBMA stands for the London Bullion Market Association and represents not only the chief custodians of gold in secure vaults (big global investment banks HSBC and JPMorgan are key players in this space) but also the key smelters and refiners of gold. In total, there are 126 members in 20 countries and this London-based association pretty much writes all the key rules for the gold bullion space globally. A Good Delivery bar for London should weigh between 350 oz and 430 oz (gold content), of minimum purity 99.5 per cent.

Some bullion dealers will offer non-LBMA Good Delivery gold which will to all intent and purpose be the same quality gold, but most traders - and certainly nearly all fund managers - will only accept LBMA Good Delivery bars, with all the accompanying standards and paperwork.

The fineness and purity (also called assay) of gold matters, with the key distinction between 22 carat gold (common in the world of gold coins) and 24 carat gold (at least 999 parts pure gold per thousand). Gold that's 22 carat includes some metal alloys which help to 'toughen' up the gold for everyday usage - British Britannia gold coins as well as American Eagles and Krugerrands are 22 carat whereas most big bullion bars are 24 carat (as are the Canadian maple leaf coins, kangaroos from Australia and pandas from China).

At the investment level, most institutions will only deal in 400 oz bullion London Good Delivery Bars, usually secured in a high-tech bullion vault probably in either London, New York or Switzerland - and worth over $600,000 per bar at current prices. Slightly confusingly, not all of these 400 oz bars are actually 400 oz of gold - the rules state they can weigh anything between 350 and 430 oz although most bars will weigh just a fraction under 400 oz.

According to ETF Securities, "bullion held Loco London is the most liquid - holding gold bullion outside London may result in metal trading at a premium or discount to the London fixing price". A London Good Delivery Bar will also come with accompanying paperwork (aggregated in the bar list for a fund) that includes a serial number (which is not necessarily unique to each bar), details of refiner, purity and assay.

Investors also need to understand that re-sizing, and refining costs a substantial amount of money - in simple terms, the smaller the unit of gold, the more expensive it is to manufacture and deal in. Everyone loves the idea of owning a vault of 400 oz gold bars but these big lumps of metal aren't the easiest objects to carry around.

Many private investors by contrast prefer portability which is why they tend to opt for coins or small kilo bars (these weigh 1,000g). But these smaller units of gold storage (coins can vary from 1/25th of an ounce through to 1 kg Australian Nugget coins, or 32.15 troy ounces) need to be refined, smelted and then reshaped into coins and bars and that introduces not only production costs, but also storage and dealing costs - these premiums for smaller weights of gold can add massive costs to ownership. Whereas the typical bid to offer spread is 5 to 7 basis points (that's 0.05 to 0.07 per cent) for an ETF Securities fund, you can easily end up paying a premium and dealing costs of at least 10 per cent for each purchase or sale of a gold coin.

One last point, gold bullion is allowable as an asset for those with a self-invested personal pension plan (Sipp) as long as it is investment-grade gold (of a purity of no less than 995 thousandths or 99.5 per cent pure), is in the form of a bar or wafer of an officially accepted weight and is immoveable and stored with a secure third-party, such as a proper bullion vault.