Brian Wilkinson, an advisor in Kitchener, Ont. with Markham, Ont.-based FundEX Investments Inc., has turned to gold to protect his clients’ investment portfolios from erosion in the face of economic uncertainty, growing government debt and the possibility of weakening currencies.

Many of Wilkinson’s clients currently have a minimum of 30% of their investible assets in gold bullion; some even have 100%. Wilkinson sees physical gold bullion as a cash substitute and safe harbour while waiting for the risks to decline in other asset classes, such as stocks and bonds. Gold bullion prices have been setting record highs, pushing against the US$1,300-an-ounce level after bottoming in April 2001 at US$256.

“Most people don’t have a problem parking cash in money market funds or bank accounts,” says Wilkinson, who has been encouraging clients to take a position in gold since 2005. Gold is similar to cash, but it’s better than government bonds or interest-bearing investments paying next to nothing, he says. “Many clients are concerned that paper currencies are in danger of losing purchasing power as governments print increasing amounts of money.”

If your clients want a piece of the action, there are a wide range of gold-related investments. Some are better suited to investors willing to take the risks of leverage or the business risks associated with finding gold and mining it. The choices include physical bullion, futures contracts and options, gold certificates, exchange-traded funds, coins, and shares in senior gold producers or junior exploration companies.

Bullion is the purest form of investing in gold — and there are a variety of ways to buy it. Bullion bars can be purchased at any major chartered bank, although Bank of Nova Scotia does the highest volume of bullion trading.

Bullion bars can either be stored in the bank’s vault or taken into the client’s possession and stored. However, the “chain of integrity” is lost in identifying the gold as pure bullion if it is not kept in proper vault facilities, and the bullion may have to be retested and recertified in the event that it is resold.

For investors looking to buy small amounts, Scotiabank’s ScotiaMocatta pre-cious metals division has launched an online precious metals eStore.

Products for sale include certificates (a paper promise to deliver a certain amount of gold), gold bars of up to five ounces, silver bars of up to 100 ounces and various bullion coins, including the Canadian Maple Leaf and South African Krugerrand. Clients are limited to purchases of $9,500 a day. Note that a certificate qualifies as a holding for registered plans such as RRSPs; bullion bars do not.

Toronto-based Sprott Inc. has also launched an online store called Sprott Money Ltd. that sells coins, small bullion bars and wafers.

Similar products are also available at an online store sponsored by Kitco Metals Inc. of Montreal.

The Royal Canadian Mint also sells products online, including a one ounce gold bullion wafer and collector coins.

For easier resale, says Richard Maskobi, managing director of ScotiaMocatta, it’s important for clients to keep receipts and original packaging, and maintain the product in good condition.

Also, gold experts say, gold bars stored at a bank must be segregated and allocated to specific customers by identification number if access to the gold is to be assured. Although there are no storage challenges with bullion certificates, gold experts say, they are not as secure as physical gold bullion. Because a certificate is a paper promise to deliver, the actual bullion may not be available in the event of a buying panic that could deplete the issuing institution’s supply. There are currently no disclosure requirements concerning the number of certificates an issuer can distribute relative to its actual bullion holdings.

“If the holding is not pure bullion but a proxy for bullion, it is subject to counterparty risk,” says Nick Barisheff, president of Toronto-based Bullion Management Group Inc. , which offers access to physical bullion through two mutual funds, BMG BullionFund and BMG Gold BullionFund. “In a major meltdown, you could have counterparty default. If the gold bullion is stored on an allocated and segregated basis, the bars belong to the customer. But a certificate or gold holding that is not allocated is nothing more than an IOU. Under normal conditions, that would be fine; but under stress, we don’t know what could happen to the system — and it’s not how you want to hold your bullion.”

BMG’s allocated bullion is stored at Scotiabank and the volume is adjusted daily according to fund sales and redemptions. Fund units are purchased and redeemed daily by the BMG, which provides full liquidity to investors.

“A pure bullion investment should be considered an investment of last resort, which means you don’t want your holding to be affected by human decisions, such as market-timing, hedging and leveraging,” Barisheff says. “It’s up to the advisor and the client to decide when to buy or sell. We simply provide the mechanism.”
@page_break@Also offering access to pure bullion are certain closed-ended funds, including Central Fund of Canada Ltd., Central Gold Trust and Sprott Physical Gold Bullion Trust. Unlike open-ended mutual funds, these closed-ended funds have a fixed number of units that trade on stock exchanges in New York and Toronto. Unit prices are influenced by bullion prices as well as investor demand for the units — and units may trade at either a premium or a discount to the underlying bullion’s value.

Another vehicle for participating in the gold party is ETFs, which have lower management fees than mutual funds. Some ETFs tie their performance to bullion prices; others to stock market gold indices, providing access to a diversified basket of gold stocks. Gold ETFs trading on the Toronto Stock Exchange include iShares Canadian Gold Sector Index Fund, sponsored by BlackRock Asset Management Canada Ltd. of Toronto, and Claymore Gold Bullion ETF, sponsored by Claymore Investments Inc. of Toronto.

Leveraged bull and bear Horizons BetaPro ETFs, sponsored by Toronto-based BetaPro Management Inc., offer the opportunity for short or long exposure to gold bullion price movements and the S&P/TSX global gold index. The exposure is leveraged by 200% to magnify the returns, both negative and positive.

Many observers are concerned that some ETFs investing in bullion do not own actual physical bullion but some form of derivative or leased gold holdings, and that this lack of direct ownership could result in liquidity issues if these funds are required to come up with the gold.

For example, SPDR Gold Trust, the largest and most liquid gold ETF trading on the New York Stock Exchange, has been criticized for its acceptance of leased gold holdings, for which there could be an endless number of “owners” of the same bullion. By contrast, Claymore Gold Bullion ETF stores its gold in the vault at ScotiaMocatta on an allocated basis.

“Our gold is allocated and segregated, and that’s a critical difference,” says Som Seif, president of Claymore. “This isn’t just an issue with ETFs; there are also some mutual funds that may use certificates or some form of derivative for gold exposure. It’s a hidden risk that is potentially there.”

David Chapman, an advisor and technical strategist with MGI Securities in Toronto, says there is a lack of transparency with some gold products and it’s important to dig into the prospectus of any gold fund to make sure it’s “the real McCoy.”

Says Chapman: “While some of the derivative products are designed for traders speculating on gold price movements, if physical bullion is desired by the client, the fund must actually be buying the bullion to back its shares — not just a call on bullion — and be able to walk into the vault and access it.”

This is less of an issue with ETFs based on gold stock indices representing a diversified basket of stocks rather than gold bullion. But because most broadly-based indices are heavily weighted in the senior gold producers, they tend to lack exposure to the medium-sized and junior companies that are higher-risk but potentially more rewarding.

Precious metals equity mutual funds offer another way to invest in gold stocks. According to the Investment Funds Institute of Canada, assets under management in precious metals equity funds stood at $4.9 billion at Aug. 31, up by 62% from a year earlier.

The advantage of an actively managed fund vs an index-linked ETF is that the active fund’s manager can decide on the mix of junior explorers and senior producers.

Fund managers connected to the information pipeline can also get in early on good discoveries and separate the legitimate opportunities from promotional hype. Because of the high risk in junior companies, it can be better to own a diversified basket of companies through a mutual fund than to try to pick one or two winners.

Mining stocks do not always move in line with the gold price, and can be affected by a variety of factors, including geopolitical risk, management expertise, hedging practices, labour costs and production problems.

Mining company stocks may also be caught up in the negative emotion of a general stock market decline, even if the price of bullion is moving upward. However, some senior producers, including Barrick Gold Corp., Goldcorp Inc. and Eldorado Gold Corp. , pay dividends, which lends some support to their stock price and provides an income that is not offered by physical bullion.

How much gold your clients should hold is a complex question. John Embry, chief investment strategist with Sprott Asset Management LP in Toronto, had previously recommended a 10% allocation to gold bullion as a portfolio stabilizer; he now suggests at least 25% in gold.

Many of the forces in gold’s favour, Embry says, are long-term trends relating to supply shortages, growing demand from emerging economies — such as China, India and Vietnam — and the lack of fiscal discipline among governments around the world. IE