Saturday, April 15, 2006

Guide to investing in gold and silver bullion

With gold flirting with $600/oz and silver almost $13/oz, there has been a lot of interest in investing in precious metals lately. The typical write-up in the mainstream media on the subject would firs acknowledge the run up from $250/oz for gold and $4.50 for silver since 2001, but then quickly segues to how gold and silver investors from 1980, when gold was at $850/oz and silver $50/oz, lost their shirts. When pressed for investment options, it would name the gold ETFs, GLD and IAU, and perhaps a few large cap miners like Newmont (NEM) and Barrick Gold (ABX). Inevitably, there will be a stern warning against owning the actual bullion, usually citing the spread and storage cost as the main reasons.

Well, the very fact that you’re reading this blog tells me that you probably don’t rely on writers in the popular press for your investment decisions. Did any of them write about gold as an investment option five yeas ago, when it would have really helped? If not, why rely on their opinions now? You will be glad to know that this author has been investing in gold and silver since 2002. Has made and maintains investments in precious metal mutual funds, stocks, and physical bullion. As always, the purpose of this blog is not to provide investment advice, but to furnish unbiased information to allow you to make your own decisions.

A true alternative investment

Gold and silver bullion (“physical” to the hard money crowd) are truly an alternative investment. They represent intrinsic wealth that is not a form of debt. Just about every other form of investment, stocks, bonds, leveraged real estate, or a certificate for gold/silver, relies on the faith and credit of another party. Even cash relies on government fiat (I’m speaking of the US$. In the case of the pound, it’s just another certificate of debt.), and is intrinsically worthless. At times of crisis, this aspect of gold/silver makes them much in demand. Ironically, you don’t have to subscribe to a doomsday view to take advantage of the safe haven status of gold/silver, as long as a sufficient number of other people do.

The other advantage of “physical” is its anonymity. Since they are not tied to a piece of paper or its electronic equivalent, bullion can be moved and stored with maximum privacy. For this exact reason however, they are not a favorite of governments whose natural tendency is to expand its control. Although far from Ayn Rand’s romantic ideals, owning a little “physical” agrees with the libertarian in me. Besides, anyone who has seen a bullion coin would agree they are truly beauties to behold.

If you do decide to invest in precious metal bullion, the rest of this post tells you what to by, where to buy, how much to pay and more.

What to buy

Most Gold bullion comes in the form of bullion coins issued by national governments. There are also gold bars like those from Credit Suisse, but they enjoy a smaller following. The following bullion coins are most often seen in North America:

American Eagle

The American Eagle is the most popular bullion coin in the US. It is made of 22K gold. The 1oz coin contains 1 full ounce of gold which means the total weight is greater than 1oz. The Eagle tends to command a higher premium (the price difference between the coin and the current quote on the metal aka the spot price) than other bullion coins.
Canadian Maple Leaf

The Maple contains 0.9999 pure gold. It appeals to purists but also scratches easily. Its premium is usually slightly less than that of the Eagle.
South African Krugerrand

The Kruggerand (or Krug for short) is the most popular bullion coin in the world. It tends to have the lowest premium, appealing to value conscious investors. Its purity is also 22K.
Other major bullion coins include the Chinese Panda, the Australian Kangaroo and the Austrian Philharmonic. All coins mentioned above come in 1oz and fractional ounce sizes of which the 1 oz is the most common. Bullion coins are also legal tender in their respective issuing countries. For example, the 1oz gold Eagle is a $50 legal tender, although it would be quite crazy to use it as such.

In contrast to gold, there are a lot more varieties of silver bullion for investors to choose from. Silver bullion do have higher premium than gold, since the fabrication cost is greater relative to the price of the metal.

Silver American Eagle

The silver eagle comes in tubes of 20, 25 tubes in a box. Each contains 1 oz of pure silver. The face value is 1 dollar. It is one of the most magnificent coins of the world.
Silver Canadian Maple Leaf
Also contains 1oz of pure silver, it has a face value of $5 CAD which is a floor for your investment if deflation is your concern.
Silver Rounds
These are coins struck by a private mint. They carry a smaller premium than the Silver Eagles or Maples.
Silver Bars
They come in all sizes, all contain 0.999 pure silver. 10 oz and 100 oz bars are the most common. They are stackable thus convenient for storage. The 10 oz bars have a shinny finish and come in plastic sleeves. On the other hand, the appearance of the 100 oz bars is more unassuming, but they offer the most efficient way for individual investors to store pure silver bullion.
Pre-1965 quarters and dimes
These are also known as junk silver. The quarters and dimes were issued as legal tender before 1965, each containing 90% silver. A full bag of $1000 face value contains roughly 715 oz of pure silver after wear and tear is taken into account. They tend to offer the lowest premium over spot.
Kennedy half dollar
Same idea as the pre-1965 coins. The Kennedy half dollar contains 40% silver. A full bag of $1000 face value contains roughly 295 oz of silver. They are legal tender so your investment is guaranteed not to drop below $1000.

All of the above are widely recognized forms of gold and silver bullion and should satisfy anyone’s investment needs. My personal collection includes all three of the major gold bullion coins mentioned, silver Eagles, 100 oz silver bars and 90% silver coins. I have left out numismatic coins whose price reflects their collectible value in addition to the metal content. I have avoided them entirely due a lack of knowledge.

There are few choices of other precious metals in bullion form: Platinum Eagles and Maples are available as are some palladium bars.

Where to buy

You should be able to purchase gold and silver coins easily from a local coin dealer or a coin show in your area. But we live in the 21st century and the same internet that brought you Amazon and eBay has also brought the most cost competitive coin dealers to your door step. At the very least the internet dealers can be used as a pricing guide. The most well-known dealers are: Kitco , Monex, Blanchard, and the Northwest Territorial Mint. However, more competitive prices can usually be found at smaller dealers such as the Tulving Company, Colorado Gold, and the Money Changer (I highly recommend reading the story of Franklin Sanders.

As with any internet purchasing, reliability is of paramount concern. Although I have never heard bad things about other dealers, I have only direct experience with the Tulving Company. I made several purchases from them in 2003-4 and never had a problem. Since then, they have since raised their minimums, but they still have some of the best prices around.

Please note 1) I’m not being paid by any bullion dealers to write this, 2) mentioning the dealers does not constitute an endorsement from me. As always, do your own diligence.

How much to pay

As hinted above, better deals can be had by shopping around a little. So let’s take a peek at the current prices from Kitco and Tulving (Saturday, April 15):
Kitco has gold and silver spot prices at $600.20/$12.96, whereas Tulving has $599.00/$12.97 probably due to different cut-off times.

* Shipping and insurance are included in Tulving’s selling price, but they do have higher minimums.

Selling

I have not sold any of my bullion, and I probably won’t for many years to come. They should be bought as long-term holdings in the first place. Indeed, the fact that they are not as easy to sell as stocks should be considered a feature in this generational precious metals bull market. But if you have to sell, most dealers will buy them from you. Both Kitco and Tulving publish their buying price on their websites which I included in the table above. The round-trip buy/sell spread for Tulving is only about 2.5% for the gold coins. We may be spoilt by sub $10.00 commissions at internet brokers, but by any measure this is a very reasonable spread for tangible goods even factoring the shipping and insurance cost for sending the coins back.

Storage

Storage is not a big problem for gold bullion since its value/volume ratio is quite high. A regular bank safety deposit box can hold tens of thousands of dollars worth of gold coins. Silver, however, is quite bulky. 1 oz = 31.1 grams, so a 100 oz bar weighs 3.1 kilos or 6.8 lbs. A full bag of 90% coins comes in a bucket and weighs over 50 lbs. When I had one delivered to my work, the receptionist was not amused :) At any rate, the metals never go bad, so a hole in the backyard is always an available option. The bottom line is, if you have to worry about breaking-and-entering, you have more pressing issues than investing in precious metals. Anyone having to use a Brinks truck to move his/her metal is not likely to be reading this blog.

Taxation

Profit from bullion transactions are taxed at the higher 28% rate for collectables instead of the normal short/long term capital gains rate. This also applies to GLD, IAU and the upcoming silver ETF, SLV. As far as I know, CEF (the central fund of Canada) is taxed at the usual capital gains rate since it is a closed end mutual fund, thus its current premium is fully justified.

Other Alternatives

Besides the ETFs mentioned above there are other ways to own precious metals. However, remember that convenience always comes at the expense of relinquishing some control. Remember also that allocated accounts will charge a storage fee.

Perth Mint Certificates
These are paper certificates issued by the Gold Corp, owned and operated by the government of the state of Western Australia, Australia. The buy/sell price is currently $605.70/595.50 for unallocated accounts. They can be purchased and redeemed world-wide.
Kitco Pool Accounts
Current buy/sell price for the gold pool is $601.70/598.00. You can redeem in physical bullion after paying a fabrication fee. Silver, platinum, palladium and rhodium pool are also available.
E-gold
A digital payment/checking system based in the Isle of Man. Deposits are stored in the form of “gold grams”. They charge a reasonable account fee.
Silver depository receipts
Silver is traded on the Comex in 5000 oz contracts. You can take delivery on a fully paid futures contract. You will have to go through your futures broker for this. See Ted Butler’s article here.
Gold CD and pool accounts from Everbank
I don’t think much of the CD and I haven’t checked out the pool accounts yet. The advantage seems to be that you can own it within an IRA.

Conclusion

The primary purpose of this guide is to provide enough information on investing in physical gold and silver such that the individual investor can decide whether to go into it at all. The actual “how-to” aspect is only a secondary concern and I expect my readers to do their own research before proceeding.

PS I have more or less completed my bullion position in the years 2003-4. For the purpose of portfolio tracking, I use a conservative estimate of 92% of Tulving’s sell price as the value for my bullion holdings. As always, taxes are not considered in tracking portfolio values and returns.