How to Profit in Gold

When we invest our savings, we usually limit our choice of assets to mutual funds, bonds, and certificates of deposit. Investing your money in these assets has traditionally been seen as the best and most straightforward way of accumulating wealth for the future… at least, that’s what we used to think. We’ve just had a lost decade in the markets, and bonds and CDs are currently yielding almost zilch. Debt woes in Europe and an ever-blossoming national debt in the USA are casting a shadow of doubt on the future of fiat. When paper assets underperform and are seen as less than trustworthy, where does one turn? Jonathan Spall, the author of “How to Profit in Gold“, may have just the information we need.

Against this backdrop of debt woes and untrustworthy paper, gold has been rising like a golden star. However, gold has not been as easy to invest in as stocks and bonds, and due to the nature of gold and of the market, it is especially vulnerable to sentiment-driven swings. For this reason, one cannot look at an investment in gold the same way one would an investment in stocks or bonds. In fact, the best way to look at gold might be as a contrarian bet against all paper and as a form of money, since it is not an investment in the sense that a stock or bond is an investment. With the future of western economies and their monetary systems in doubt, knowing how to profit from gold is becoming more important than ever.

What’s driving the price of gold?


The author first starts out by examining the various factors driving the price of gold, such as the effects of selling by central banks as well as past central bank agreements, changes in market sentiment, and the increasing ease of investing in gold due to new investment vehicles, such as online pool accounts and ETFs. The author notes that central bank selling has been a predominant driving force in the gold market in the past, though it is experiencing a declining pace today. Market sentiment, however, has changed vastly since the 1990s. In the late ’90s, technology stocks were all the rage, and gold was seen as the barbarous relic of a bygone era. Indeed, at sub-$300 prices after nearly two decades of price declines, it’s hard to imagine how gold could have stirred much excitement at all. This has all been changing in recent times, with the recent global financial crisis as well as the burgeoning debt of developed economies causing investors to look for a safe haven, and gold has traditionally been a safe haven investment.

The gold market

The gold market contains many players, such as the central banks and various organizations such as the IMF, as well as the markets, miners, and dealers. The author covers each of these players, and covers them in depth and detail. You will learn how gold is traded and lent between various players, how it is cleared, and how each major exchange operates. You’ll learn about the London Bullion Market Association and how it operates, you’ll learn about different terms such as contango and backwardation, and you’ll also read about the impact of miner hedging strategies, as well as the impact of hedge funds. The author even covers the gold conspiracy, a belief that central banks and other actors have conspired to artificially suppress the price of gold in the past, and gives his thoughts.

The next steps

Once you’ve learned what drives the price of gold, how the gold market operates, and how the different players interact with each other, you’ll want to know how to invest in gold and profit from it. The author covers the major categories, including ETFs, mining stocks, and physical bullion. As the author has spent considerable time in Asia, he has many interesting insights to share on the differences between eastern and western cultures, particularly in respect to gold. Finally, there is a comprehensive FAQ and glossary which covers all of the major terms, as well as the most frequently asked questions.

My thoughts

I’ve been interested in gold for a while now, and I enjoyed this book as I gained a deeper understanding and appreciation for how the gold markets work and how it’s traded, as well as the various factors that drive gold and play into its price. You won’t learn everything there is to know about a gold investment after reading this book, but if you are interested in purchasing gold, this book will definitely whet your appetite! This book is written for the diligent and responsible investor, so I do recommend that you proceed with caution if you are prone to getting caught up in market sentiment, chasing losses or following the herd.

About the author

From the inner fold: “Jonathan Spall has worked for Barclays Capital for six years. As the product manager for precious metals, he is responsible for commodity relationships with central banks and governments on a global basis. He spent ten years at Deutsche Bank, most recently as a London-based director with responsibility for official sector marketing (commodities) and head of metals marketing (Europe/Africa). Spall earlier worked for Deutsche Bank in Hong Kong and Australia as head of metals.”

So, reader, what are your thoughts about gold? Is it headed for a bubble and a burst just like in the early ’80s, or is this really a story about the declining value of paper assets, with gold as the ultimate safe haven? As always, I’d love to hear your thoughts; in fact, by leaving a comment you will be entered to win a free copy* of “How to Profit in Gold“, courtesy of Invest It Wisely!**

*free copy will only be shipped within Canada and the USA. Giveaway ends when 2011 begins.

**The contest has ended; thanks for your participation!

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About

Kevin has left the office, and he is currently fighting the rat race by working on his own business. He enjoys exploring unvisited places around the world and gaining new experiences. He believes that by properly managing our energy and time, we can learn to invest our lives wisely.

43 Comments Kevin on Dec 23rd 2010

43 Responses to “How to Profit in Gold”

  1. I’m a “buy it when everyone else hates it” kind of investor. All the consensus around buying gold is flashing up warning signs to me. That doesn’t mean gold can’t still go up, especially with all the countries around the world trashing their own currencies. But it doesn’t look like a bargain to me at the moment.

    • Kevin says:

      If gold were to suffer a sentiment reversal and drop by a few hundred, I wouldn’t mind picking up a bit more. I personally haven’t made any purchases in a while, as I am close to my target allocation of 10% at these current prices.

      • A 10 – 20% drop in price would start to perk some interest on my part too. I still have a number of gold-bug books from the late 1970s/early 1980s that I picked up in thrift stores for something like 25 cents each after the bottom fell out of the precious metals market back then. But I have to admit all this quantitative easing is pretty scary stuff and inflation in commodities, food and energy is definitely picking up.

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  3. I own some gold through ETFs, but when perusing the bookstore, I saw books like this and others and wondered – is it really necessary to write and buy and entire book on this? It’s usually pretty straightforward – buy bullion, ETFs, stocks of mining companies; quick google search gives plenty of options, pros/cons to each.

    I even saw a book on Twitter and laughed at how it’s probably completely obsolete and useless by the time it hit the shelves.

    • Kevin says:

      That’s a very good point, but I think that the two can go in combination. I could see the book being useful for someone who knows the basics of investing but not the particulars of the gold market. They could find the same info online, too, but it could take longer and they might not know what to search for if they are not aware of it. The book could give them that base, which they could then build upon by doing their own research and following up.

  4. Jenny says:

    I got interested in gold a few years ago and started to look at ways to invest in it. Mining companies were/are a good option as I read most are old and new ones aren’t cropping up. I also felt having some gold bullion on hand-important to be in my possession and not at some holding company. But the prices were/are just too high to get even some small amounts. I ended getting some real silver instead. Always the lesser cousin, but at least I felt better to have a real metal commodity on hand. There are some precious metal companies in the us where you can buy coins of each as well as pure bars of gold or silver. You know, when all the banks were going to crash and we were going to need it. We probably will someday. :)

    • Kevin says:

      I was interested in junk silver before the prices skyrocketed. ;) I currently hold something like 8 to 10 percent of assets in precious metals, with that predominantly being gold and platinum. That’s a good target for me, though I do find the current prices a bit high.

  5. Jessica07 says:

    I’ve been doing a lot of reading about gold lately. There seems to be rather wide consensus that it’s going in the direction of a bubble. However, as you say, it could just be a symptom of paper money’s decline. I’ll be getting a hold of the book you just mentioned as soon as I can. Thanks for the tip.

    • Kevin says:

      I’m not sure about the bubble talk. Are current prices high? Yes. I would not recommend investing large sums just because people are talking about gold these days. However…. lots of things have risen a lot, like oil and other commodities. This isn’t just a story about gold. Any asset is vulnerable to a bubble, but if the current price is accurately reflecting fundamentals as they currently stand, then although the price is high, it’s not necessarily in a bubble. So, is it in a bubble? Maybe, but not necessarily so. There are good arguments on both sides.

      I would still be happy if the prices pulled back a bit due to people believing it’s in a bubble, since that would give me a chance to get in cheaper. ;)

      • Kevin,

        This is an interestng take and one I think is acurate. If you look at the historic price of gold, based on inflation, it looks pretty high. But, if you look at the historic price based on the real rate of inflation (not the goverment’s fake CPI) it’s not as high as everyone thinks. That’s why I think oil, gas and food are also going up much faster than the government would have us believe. The dollar just isn’t worth what it used to be and it shows on the open market.

        • Kevin says:

          Re: CPI I agree! I don’t have too much faith in the rate of inflation as reported by the CPI. If you compare with a few years ago to today, gas, housing (maybe not so much in the US due to the crash), etc… are all much more expensive, yet this inflation is under-reported by the CPI or outright ignored, and incomes haven’t risen in lockstep. With a stable money supply, if some prices go up, others should come down. We’ve been seeing some of this, but I think we would have seen a lot more if not for efforts to inflate the economy and prop up asset prices. I believe that these efforts to keep prices higher than they should be is one of the major components underlying the story of gold and other commodities.

          • Kevin,

            The goverment changed the way it calculated the CPI back in 1990 and it has been under-reported ever since. The primary reasons are that the government couldn’t afford the additional interest on Treasury bonds or the COLA (Cost Of Living Allowances) for Social Security, Welfare and pensions.

            There is a great website called ShadowStats.com that reports the CPI, based on the pre 1990 formula and it averages around 4%. I think that’s much more accurate than the 1% of the new CPI.

  6. Moneycone says:

    I’m always intrigued by gold! I think gold has its place, I won’t simply dismiss it. When the market is doing great, I wouldn’t invest in gold. If the market is headed to the dumps, gold is a consideration.

    • Kevin says:

      That’s one of the points that the author made in the book as well. There was a time where the market was a great buy and gold should have been sold, and that was back in the beginning of the 80s. Eventually this pattern reverses, and the market was a clear sell at the end of the 90s. It goes back and forth in cycles, so there are times for both.

  7. Squirrelers says:

    I think it’s a good idea to keep some component of one’s portfolio in gold. The only thing is, I’m also a believer in bubbles. Gold seems to be priced quite high by historical standards right now. Nonetheless, the book seems interesting. Personally, I haven’t been investing in gold but based on my initial sentence in this comment, it’s an area that I would like to spend a little more time researching further.

    • Kevin says:

      One thing I noticed when I picked up a gold bullion is that it almost felt like I was doing something illegal or strange. It’s time for our society to stop looking at gold like it’s voodoo or witchcraft: In many other parts of the world, there’s nothing special about it and it’s perfectly normal to keep bullion or a significant amount of jewelry at home. My girlfriend’s cousin’s grandfather (IIRC) used to have a chest full of bullion under his bed… and there was nothing unusual about this. Too many of us forget that most parts of the world have had the SHTF in some form or another, and though paper money can become worthless, gold does not. Do we really have so much hubris as to think something like this can never come to our shores? Our governments may think so, and Europe thinks so, but they may just be buying time.

      Ideally, the banking and monetary systems would be moral, fair, and mathematically sound, and there would be little need for gold beyond its aesthetic value, but the reality is far from the ideal situation, and gold is the universe’s way of imposing order and soundness. Until now, nobody’s figured out a way to conjure gold atoms out of thin air. ;)

  8. Mark says:

    I think that a bubble is forming in the market. It’s not bad as 5% of a portfolio but people are making it 25% to 50% of their portfolios. Every bubble must burst!

    • Kevin says:

      50% certainly might be excessive, especially if loaded up at $1400! Any asset can enter a bubble, but I don’t quite see the same kind of frenzy that was occurring in real estate, with people entering with no money down and with a huge portion of the population participating.

      I wouldn’t go for 25% – 50% and up (unless it was 2002 and I had a crystal ball), but in many eastern countries, 10% and up is completely normal among the populace. In western countries, our central banks are full of gold, but the people don’t have much. Maybe things will balance out at some point.

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  10. jim says:

    @Mark – Totally agree. A little bit of gold (or platinum or pladdium or silver or copper etc) is never a bad thing in a portfolio. 20% is really pushing it. Beyond it being a shiny stuff it has no ‘real’ value. It can’t produce income for you and you can’t eat it. By investing in precious metals you are betting on the greater fool theory – that someone will buy it from you at some point in the future for more than you paid for it.

    • Kevin says:

      “Beyond it being a shiny stuff it has no ‘real’ value. It can’t produce income for you and you can’t eat it.”

      This is also true of cash kept at home or in a chequing account, so I think it’s better to compare gold to these types of assets rather than to compare it to stocks & bonds. An interesting hybrid would be a gold-denominated bond.

      Gold has the advantage of being independent of the banking system (if held allocated), and it has the disadvantage of being a bit less liquid than cash. If you were going to keep 10% in cash, then you could consider 5% in cash 5% in gold. I personally am around 8-10%, though if I had gotten in at early 2000s prices I wouldn’t mind having a larger % in.

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  13. Mike says:

    This seems like a good book as far as the basics are concerned, definitely a good place to start.

    IMHO, the challenge for investors is to take time to do your research on gold. I hear more people saying gold is in a bubble than I hear people saying they actually own gold. IT does make sense that no one would want to buy an asset class that could burst. But I would challenge people to at least consider that gold bull market has years to go.

    Moreover, don’t rule out the possibility of gold being pegged to the dollar at much higher prices. Sounds crazy? It does until you step back and look at who the largest holder (via country) of gold is. I posted 2 cuts of a presentation done by Jim Rickards – where he explain how he sees this occurring down the road.

    If/when this happens, the bubble would most likely be in gold stocks. Either way, due diligence and patience apply.

    • Kevin says:

      Thanks for sharing the presentation, Mike. I think that a “freegold” outcome might be more likely than a peg, but we’ll have to see what comes down the road. Re: Bubble, I really don’t think that 10% is such a risky allocation to go with. People were dumping their entire portfolios into tech in the late 1990s and housing in the mid 2000s. I don’t see many people going all-in with gold; especially not mom & pop. Few people believed those markets were bubbles at the time, but everyone thinks that gold is in a bubble right now. The mania phase might come, but it doesn’t seem like we’re there yet.

  14. Good article, Kevin, and some interesting points in the comments section. To the comment about gold not producing any income, that is true enough, but I might add that neither do collectibles (cars, antiques, etc.), cash in hand, non-rented real estate, or underwater-mortgage homes. And yet, I’ve seen some of those being called “investments”. Look at gold and silver and other precious metals as stores of value, and the perspective changes a bit.

    • Kevin says:

      Great point, Andrew. Money doesn’t have value except what it can be exchanged for, but gold holds its value better because it cannot be arbitrarily manipulated as easily as paper money can. When trust in paper money is lowered due to crises or abuse of the printing privilege, gold is the natural counterweight. Unlike paper money and until we figure out how to scrape it from the sea at low cost or some other crazy invention like that, gold’s scarcity is enforced by the laws of the universe.

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  16. Hi Kevin, this sounds like a good book for newbies who have heard about gold, but aren’t sure what to do next. I have quite a bit of my savings invested in precious metals as well. That’s because I believe it’s a store of value, otherwise known as money. It’s been a much better form of money than the US dollar for the past decade.

    I totally agree with Mike that more people believe gold is in a bubble than own one single gold coin. I’ll believe it’s in a bubble when it makes the cover of Time magazine, and people want to talk about their gold stocks, rather than thinking me weird for owning gold. I will also worry about a top when gold’s chart looks more like the Nasdaq of the 1990s, rather than the gentle upslope you will see on a 10 year chart.

    I’ve heard commodity bubble talk since at least 2006, probably earlier. These are usually the same commentators who didn’t see the actual bubble in real estate at the time. Inflation adjusted, gold is still several hundred dollars below its 1980 high. Economic conditions like real unemployment, debt, and the disappearance of the manufacturing sector are much worse today than they were in 1980. As Bernanke prints more money, the currency debasement will help push gold higher.

    • Kevin says:

      I agree; perhaps in 3-4 years we may see a NASDAQ-style chart forming, but it doesn’t look like we’re there yet. A unique theme is that everyone is sure that gold’s in a bubble, and that negative sentiment was not there AFAIK in the run-ups to the tech and housing bubbles.

      The huge debt overhang facing the developed countries is definitely worrying. I think that it’s possible for the western nations to work through it without living standards falling through the floor, but a working through of the debt will most certainly lead to lowered living standards for those used to a debt-fuelled lifestyle, and lowered government benefits which will no longer be sustainable.

  17. Hum, interesting sounding book, and interesting discussion about gold. I think that gold can have a place in someone’s portfolio, at least about 5-10% of said portfolio (with commodities as a class making up no more than 20% or so, if that much), but as others have said, right now, the market feels kind of bubbly. I have the sense that the market could be heading for a correction (if only because everyone is worried that we are in a bubble, and there ends up being a rush to get out). When I have more money available, I will definitely consider holding a portion of gold, although at the moment, it seems more likely to go down than up in the near term.

    • Kevin says:

      That may happen, and if it’s a good sized dip I don’t mind adding a bit more. I don’t see that the Titanic has reversed course, yet… my friend http://www.beatingtheindex.com specializes in oil & natural gas, so if you’re interested in commodities you might find some interesting reading material over there!

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  19. Kidgas says:

    Well, I am a firm believer in gold mainly because in late 2003 or so I learned about Kondratiev and his long wave theories. The long K-wave seems to make sense because it seems like it is based upon the length of an investing generation. It would make sense that a whole generation of investors have dismissed the stock market and real estate as decent investments meaning that commodities are left to fill the void.

    The key will be identifying the changing of the investing seasons. I would suspect that there are several more years left to the gold story based upon an average length of a cycle. By the way, I have over 25% of my retirement funds in Goldcorp stock. But at the same time, I have protective puts in place to protect against a sudden drop. It is one thing to have conviction, but is another to be stupid.

    • Kevin says:

      It does seem that many asset classes rise and fall in cycles. It’s a natural progression as money flows to one asset class, that asset class becomes expensive, and another becomes comparatively cheap. We saw it in stocks a couple decades ago right around the time of the last gold bubble… and then gold became quite cheap right around the time when everyone was rallying around tech stocks. The catch is that everyone usually thinks that said asset is doomed at that time, which is why they get ignored… but for a contrarian investor, they could be the perfect buy.

      Good luck in your investing adventures!

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  23. Thanks for your review, I will get a copy shortly. I have some gold coins, and I too have invested in gold ETF.

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