There are many different investment vehicles one can use to invest in gold but the key aspects that we as investors and traders must always look for are the vehicles’ relationship and correlation with gold prices, and how much that correlation is or isn’t leveraged to the gold price.
Ways to Use Leverage to Maximize Gold Returns
a) Buying on Margin
A simple solution to achieve this is by using margin, i.e. borrow money and buy twice as much GLD and you will get approximately twice the return than you would have earned without buying on margin. Not all investors are comfortable with margin, however, because with gold being so volatile one could be caught out and face margin calls.
b) Buying Gold Stocks
One of the most popular methods for those looking to invest in gold with additional leverage is gold stocks although we don’t think this is the best way. It is not that there aren’t some gold stocks that are well worth investing in, as there certainly are some fantastic opportunities and a lot of money to be made in gold stocks, from the heavyweight miners to the junior resource start-ups. It is just that gold stocks do not score highly in one of the main aspects we look for – correlation to gold prices.
While it is true, in general, that as gold prices have been rising gold stocks have been making great gains, we feel there are simply too many other external factors that have little or nothing to do with the price of gold and yet affect the investment, diluting gold stock’s correlation to the gold price. Such external factors are things like:
a) increasing costs,
b) geo-political unrest in the region they are mining in,
c) foreign exchange fluctuations and
d) changes in management.
The junior resource companies are even less correlated than the miners with their stock prices moving, not on the gold price today or in six months from now, but more on:
a) whether or not they find any gold,
b) how much gold they find,
c) where they find it,
d) what grade the resource is and
e) whether the project will be feasible to mine in many years to come.
When looking at the leverage of gold stocks relative to gold prices, while they do exert some leverage and regularly outperform the yellow metal, the extent to which they do varies considerably and it is hard to calculate how much leverage a stock will give you due to the external factors detailed above.
c) Buying Options
As such, in our quest for the best gold investment vehicle – one that exerts direct undiluted correlated returns to the gold price with added leverage that is quantifiable to a reasonable accuracy – we think that options are the best choice because options contracts are:
a) directly linked and correlated to gold, without the hassle of the external factors that often hamper gold stocks
b) not only a leveraged product but one that can be tailored to suit ones degree of leverage preference with the right combination of contracts
c) risky but an investor can choose how much risk they wish to take on, and in some cases owning options results in less risk than owning gold stocks.
In our quest for the best gold investment vehicle – one that exerts direct undiluted correlated returns to the gold price with added leverage that is quantifiable to a reasonable accuracy – we think that options are the best choice.
The comments above are edited ([ ]) and abridged (…) excerpts from the original article by Sam Kirtley
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