How to invest in gold

Gold has been coveted for millennia because of its beauty, rarity and virtual indestructibility. In the current economic climate gold continues to have merit as a store of wealth. Gold as an investment has grown in popularity in recent years, partly because of the risks posed to our modern global financial and economic systems – it is often seen as a safe-haven in times of crisis. The price of gold bullion fluctuated between $1,500 and $1,800 during 2012.

In the shorter term, economic growth has remained constricted, and deflation is just as much a risk as inflation. However, policymakers continue with their quantitative easing programmes in an attempt to boost flagging economies, which can also have the effect of devaluing currencies and stoking inflation. Many commentators believe this could be a real long-term threat.

Although gold doesn't produce any income it could help preserve the spending power of capital while interest rates remain below the rate of inflation. Gold cannot be debased in the same way as paper currencies (you can't print more gold) and while traditionally considered a hedge against inflation, it could also provide shelter against deflation.

Demand from central banks also remains robust, particularly in emerging markets where governments are trying to diversify currency reserves away from US dollars. In China gold accounts for less than 5% of reserves, compared with around 75% in the US and over 70% in Germany.

Generating the supply to meet the increased demand could be a challenge. Few central banks are willing to sell their gold to meet the demand of others, while it is becoming more difficult to extract gold from the ground. According to Ani Markova co-manager of the Smith & Williamson Global Gold and Resources Fund, on average it is estimated twice as much rock needs to be mined today to extract the same amount of gold as in the 1990s. Most high-grade reserves are also located in hard-to-reach areas, or less politically stable regions.

How can investors gain exposure?

There are a number of ways investors can gain exposure to gold, and as ever the best route will depend on individual circumstances and attitude to risk. Gold is a specialist area, and so can be more volatile or subject to unique pricing factors, as such we would only suggest a small allocation as part of a balanced portfolio.

Sophisticated investors looking for exposure to physical gold bullion could consider an exchange traded commodity (ETC) which aims to track movements in the gold price. They can either hold physical bullion, stored in vaults, or gain exposure using derivatives. It's important to remember that once fees and charges are taken into account the ETC will not track the gold price exactly. They are also subject to additional risks, especially those that use derivatives. Particular attention should be paid to the financial security of the company holding investors' assets, or that of any counterparty with which derivatives contracts are made.

If the gold price rises, companies able to maintain or reduce costs could increase the profit they make on each ounce of gold produced, in turn potentially leading to rising share prices. However, there are no guarantees and investing in the shares of gold mining companies is considered higher risk than investing in physical bullion.

For adventurous investors looking for exposure to gold mining shares the Smith & Williamson Global Gold and Resources Fund features on the Wealth 150 list of our favourite funds in each sector. Managers Ani Markova and Robert Lyon tend to have a bias towards higher risk smaller companies. After performing poorly during 2012 they believe a gap has opened between the valuations of gold mining companies and the price of physical gold. They believe this gap could begin to close during 2013, as interest rates remain low, governments continue to print money, and gold remains attractive in the current environment.

The Smith & Williamson Global Gold and Resources Fund was recently highlighted as our 'fund in focus'. Read the Smith & Williamson Global Gold and Resources fund in focus »