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A one kilogram gold bar is seen here in a store in Dubai.
A one kilogram gold bar is seen here in a store in Dubai.

Portfolio Strategy

Buying gold: An investor's guide Add to ...

Gold's gone legit.

It's no longer just the speculator's delight. Think of it today as an asset class separate from stocks and bonds that you should consider having permanently in your portfolio. You don't need a lot, but you do need some. If there's a universal lesson taught by the global financial crisis, it's to be prepared for unexpected disruptive developments. Gold is the best hedge against uncertainty there is, and it's also a useful thing to have in your portfolio if inflation is rising, as some foresee, or if the U.S. dollar's decline worsens.

The first question to address in adding gold to a portfolio is how much you need.

The standard advice for "specialty" type investments like gold is an absolute maximum of 10 per cent of your portfolio, with 5 per cent being a more typical ceiling for the average investor. There's research that shows somewhat higher weightings are better, though. The U.S. firm Ibbotson Associates did a study for Canada's Bullion Management Group a few years ago that found investors can potentially improve their balance of risk and reward with a precious metals weighting of 7.1 per cent in conservative accounts, 12.5 per cent in moderate accounts and 15.7 per cent in aggressive accounts. Precious metals can include silver and platinum, but it's a term that primarily means gold.

Trade by Numbers: Read more about investing in gold:

  • Gold could go higher, but that doesn't mean it can't fall first
  • Mining Canada's gold producers for hidden value
  • Discussion: Investing in precious metals?
  • A bear on gold when the rest are bullish
  • Buying gold: An investor's guide

Next step: choose a vehicle for investing in gold.

Let's quickly dispense with buying actual gold in the form of bars or coins. This is growing in popularity to a point where a division of Bank of Nova Scotia called ScotiaMocatta has opened an online precious metals store ( scotiamocatta.com/eStore/). Owning physical gold does make sense if you're a survivalist or generally concerned about the complete breakdown of society. Otherwise, you have an asset that needs to be protected - don't leave it sitting around the house - and can't be easily integrated into your overall investing strategy.

This brings us to the following options for mainstream investors:

Individual gold stocks: The Toronto Stock Exchange (TSX) is a gold mining centre, with listings that include giants like Barrick Gold and Goldcorp . Note the added layer of risk with gold stocks. Not only do you need gold prices to rise, but you also need your gold company to be a well-run business. Something else to be aware of is that gold stocks and gold bullion don't always move in unison.

Precious metals mutual funds: These funds are among the most expensive in terms of the fees they charge, but they have a long history of bringing the benefit of rising gold prices to individual investors (and the opposite, of course). These funds tend to hold the shares of gold mining companies, but they may also invest in producers of silver, platinum and other precious metals. Some may hold certificates representing actual gold and silver bullion as well. One mutual fund that invests strictly in gold bullion, as well as silver and platinum, is BMG BullionFund.

Exchange-traded funds: There are two kinds of gold ETFs, one of which tracks the price of gold bullion and is thus a clean, convenient proxy for holding physical gold. Examples include the iShares Comex Gold Trust, which trades on the TSX under symbol IGT and on the New York Stock Exchange under IAU . Another NYSE-listed option is the StreetTracks Gold Shares ETF . The other kind of gold ETF tracks an index of gold mining stocks like, for example, the iShares CDN Gold Sector Index Fund , which follows the S&P/TSX Global Gold Index.

Closed-end funds: Think of these as conventional mutual funds that trade like a stock and thus can be bought or sold any time during the trading day (mutual funds can only be sold at end-of-day prices). Closed-end funds differ from ETFs in that they can trade at significant discounts or premiums to the net asset value, whereas ETFs will veer away from their net asset value only temporarily and mildly. Several closed-end funds offer a way to hold actual gold, including the new Claymore Bullion Trust and Central Gold Trust .

Whatever gold investing vehicle you buy, make sure you understand how it works.

Two key questions to ask: Am I investing in gold stocks or gold bullion, and am I exposed to Canada-U.S. currency fluctuations?

Remember gold is priced in U.S. dollars and a rising Canadian dollar will undercut your gains. This won't be a problem if you own a precious metals fund that holds TSX-listed gold stocks, but it might be if you have a fund tracking gold bullion prices (unless it uses hedging, like Claymore Bullion Trust).

Gold's rise past $1,000 (U.S.) per ounce this year has created a lot of excitement and raised expectations of more gains to come. You're not buying gold for a quick score, though. The reason why gold's a legitimate asset class for investors today is its potential to shine when all else is bleak.

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