If you decide to bet on gold, be sure to pick the right investment vehicle

As gold catapulted to another record high last week on its run to who knows how high, some investors may be wondering if buying in now will leave them enough room to make a profit on their investment. While analysts and traders are telling anyone who will listen that gold is heading higher still, individual investors should be aware of gold's volatility as an investment. Diversifying a portfolio with gold may not make sense for everyone.

If you listened to Wall Street this week, gold sounds like an investment no-brainer. On CNBC's SquawkBox Wednesday, Lou Grasso, a gold trader at Millenium Futures and Peter Schiff, president of Euro Pacific Capital were bullish on gold. Grasso's prediction of $1,800 an ounce was characterized as "cautious" while Schiff's projection of "$5,000 an ounce before Barack Obama leaves office" (Is he suggesting 2012 or 2016?) understated as "optimistic."
Resistance Is Futile

When the professionals are forecasting 50% growth from its current level, how could anyone resist gold? The problem is no one is resisting. Gold has risen 3.7% this week and 37% since Jan. 1. There are a number of reasons for gold's rise, including the structural decline of the US dollar, rising inflation expectation and financial market uncertainty as Dan Burrows outlined in a DailyFinance post on Wednesday. But gold still carries significant risk.

In fact, the risk associated with gold was on display this week: gold hit another record high on Thursday, as gold futures (/GC\Z09) climbed as high as $1,226.40 an ounce before settling to $1,207.50. Then, gold plummeted Friday morning and ended down $60.60 for the day as investors took profits after positive news on unemployment.

Such is the volatility that comes with a commodity that doubles as a currency. So individual investors must be clear on why they want exposure to gold, what their risk tolerance is and which investment vehicle they believe can best achieve their goals.

Decisions, Decisions

"The investor has a real choice to make," said William Rhind, strategies director of ETF Securities, "Do you want to own gold, or do you want to own something that gives you the performance of gold, but is not gold?"

If investors decide to buy gold through an exchange traded fund (ETF), they gain access through a liquid and trade-able format that is backed by physical gold and tied to real movements in the gold market. In general, ETFs trade like stocks and are one of the cheapest and least risky ways to invest in gold.

"With an ETF, investors can access the gold market just as easily as buying shares of IBM or Exxon," Rhind said. However, they don't carry the same risk of going out of business like investing in individual gold stocks. Rhind's firm offers the ETFS Gold Trust (SGOL), and another choice is the State Street Global Advisors SPDR Gold Trust (GLD).

Of course, investors can buy gold stocks, which generally fit into the mining category. But Standard & Poor's equity analyst Leo Larkin, said gold stocks tend to be more volatile than gold itself. "When the price of gold goes down, [gold stocks] fall more, and when the price of gold goes up, they rise more," he noted.

Coin Collecting

With that type of volatility risk, the high costs of mining gold and the fact that the current rally has boosted gold stocks significantly this year may make them a bit pricey with little upside left.

Investors can buy physical gold, such as gold coins, but people usually do this only when they expect to hold the gold for a very long time. Gold coins and bars are low risk, but the transaction costs of buying and selling them is high. And storing and securing them presents other problems, so they rarely trade. But they can be the right vehicle for many investors.

"If your objective is to hedge against foreign currencies, you might be better off buying gold coins," said Larkin.

Another way to get exposure to gold is to buy gold mutual funds, which allow you to invest in a number of gold-related companies, but without the risk of being tied to only one company's fortunes. S&P recommended a number of gold mutual funds highlighted in an earlier post.

Beware of the Future

About the only way individual investors should not gain exposure to gold is through options and futures. "Leave those to the professionals because they involve using leverage," Larkin warned.

Since most analysts expect gold to spike whenever inflation begins to rear its ugly head, you can expect speculators to keep loading up on their positions and pushing prices higher over the short term. Uri Landesman, ING Investment Management's head of global growth, suggests that about 25% of the market is on a gold-buying binge because they view it as a currency.

"There is a certain percentage of the population that is going to keep on buying gold, and these gold people almost exclusively add to their bets." he said.

If you are not in that camp, just make sure you cash in your bets on gold before the speculators do.
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