Commodities and Futures: The options for gold

SO YOU want to get in on the gold rally?

The run-up has been thrilling. Last week the price closed in London at dollars 375.50 an ounce, an increase of about 15 per cent in 10 weeks.

If you are thinking of investing in gold, and are not enormously wealthy or financially sophisticated, consider a few things before you do anything.

First, many gold analysts are saying that the recent advance is a speculative bubble ready to burst at any time. If the big US commodity funds fueling the rally sell suddenly, a small investor could lose his shirt.

Second, don't invest any money you cannot afford to lose. Ask a financial adviser if in doubt. What is good for George Soros and Sir James Goldsmith, the high-rollers who triggered the rally, may be daft for you.

The World Gold Council advises investing only funds that will not be needed for two to three years, and says that only a portion of a portfolio should be devoted to gold as the price can rise and fall sharply.

Individuals living in the UK have several choices when it comes to investing in gold. The costs and risks vary widely.

Jewellery, coins and bars are the most obvious way to buy gold. Your wedding ring or grandmother's earrings are invaluable to you. But they are unlikely to be pure gold (unless purchased in the Middle or Far East) and thus not the best way to invest.

Gold bullion coins issued by mints are the most direct investment. They can be purchased through banks and gold dealers over the phone, are guaranteed, and come in a variety of sizes.

If you buy gold coins in the UK, you must buy them in sterling and automatically take on a currency risk, because gold is traded in dollars. But their main drawback is that VAT of 17 1/2 per cent is charged if the coin is delivered to the purchaser in the UK. That means that gold prices would have to rise 17 1/2 per cent before the owner could begin to see his investment appreciate. To avoid the VAT, a buyer can have the coin delivered offshore where it is registered in his name. Mike Temple, director of London-based dealers Gold Investments Limited, usually recommends the one-ounce, 22-carat, South African Krugerrand coin. When delivered offshore its price is closest to the current world gold price than any other coin.

Coins minted elsewhere are available but cost more.

Last week, with gold at dollars 380, the Krugerrand for UK delivery cost around pounds 291 including VAT and commission. An offshore Krugerrand was pounds 250, including storage, insurance and commission. Had you bought one a month ago, the price would have been pounds 217.

Small gold bars can be purchased the same way, but cost about pounds 10 more per ounce than a Krugerrand and have a lower resale value than coins.

An investor who can afford to buy more than 100 ounces of gold, or pounds 24,000-worth, might look into the equivalent of a gold savings account from a bank. He can buy bars on an unallocated basis, where he is recorded as holding a specified amount without reference to individual bars. He can have bars allocated to him but this attracts VAT in the UK.

For those who desire a faster-paced arena, look no further than gold futures and options, where a big exposure to gold is gained for a fraction of gold's cost.

Check the ads in the financial press for futures brokers and call the Securities and Futures Authority, the industry regulator, to make sure the firm is a member. Firms often require a minimum investment of pounds 5,000 to pounds 10,000 to set up an account.

With gold futures, the potential losses are unlimited. Lind Waldock Discount Brokers in London says that for exposure to a 100-ounce gold futures contract traded on New York's Comex, worth dollars 3,750 last week, a customer pays an initial margin of around dollars 1,500 and a dollars 36 commission (other firms can charge up to dollars 2,000 and dollars 100 respectively). Margins can increase when prices move sharply. If the market moves against the customer he has to pay additional margin, possibly daily.

If the gold price falls dollars 10, the investor has lost dollars 10 an ounce, or dollars 1,000. If the price rises dollars 10, he will be ahead dollars 1,000. He close out his futures position at any time but may not be able to exit the market at a good price.

Gold options, also traded in New York, are less risky and cheaper than futures. All you can lose when buying call options (the type advised for small investors, where no margin is required) is the initial payment.

Last week, an investor could buy a December dollars 420 call option for dollars 9. If the price rises to dollars 500 an ounce by December, the dollars 80 increase translates to dollars 2,400 profit on one, 100 oz contract. If it never reaches dollars 420, the customer loses the dollars 9, plus commission.

Gold shares give the buyer exposure to a mining company, a country's economy and politics, currency and gold prices. South African gold shares are tinged with potential political risk, Australian and Canadian shares can be volatile, and US shares tend to be the most expensive.

In the UK gold unit trusts, which invest in a spread of the world's gold shares, give you share exposure with the benefit of the fund manager's expertise.

After a tough 10 years, they have been stellar performers recently. If you had invested pounds 1,000 in Mercury Asset Management's Gold and General Fund six months ago, your money would have grown to pounds 2,360 by last week. Save & Prosper has one too, more lightly weighted in South Africa than MAM. Investors can enter for a minimum layout of pounds 1,000 and 5 1/2 per cent initial commission.