Gold is going higher! The Dollar will soon be worthless! Every other television commercial seems to scream that gold – and gold alone – will secure your financial future. Maybe the warnings are sound. At the very least, gold represents a diversification from the stock, bond and real estate holdings found in a typical portfolio.
But what’s a would-be gold owner to do? Buy a gold coin on eBay? Open a commodity account to trade gold futures? Or call one of the TV pitchmen? Is counterfeiting a possibility?
What could possibly go wrong?
Unfortunately, the benefits of buying gold sometimes drown out the potential pitfalls for an inexperienced buyer. Gold can be purchased in a number of forms – some of which are more or less affordable and appropriate for a given investor. Brokers and salespeople tend to push whatever they have and gloss over alternative forms of ownership. Before you jump into gold or any other precious metal, be sure you understand your alternatives.
Gold Ingots or Coins
Good: Coins are widely recognized as being valuable because people are used to non-gold coins. Ingots – little bars of gold – are also somewhat familiar and therefore, freely exchangeable. Pure gold doesn’t corrode and is easily stored/concealed. And possession is key compared to gold ownership represented by a piece of paper.
Bad: When buying physical gold, you’re charged more than the exact, current market price. How much more depends on how much you buy and who you buy it from – so shop. And when some TV commercials and their salespeople tell you there is “no counterparty risk”, ask them about counterfeiting and clipping – shaving away tiny quantities of metal. As gold becomes more valuable, the incentive to defraud grows.
Good: Advocates claim that collectible or numismatic gold coins are less likely to be confiscated by the government in times of economic emergency. After all, they were exempted from President Roosevelt’s 1933 gold nationalization.
Bad: Collectible value can be difficult to determine. Condition and rarity are key to collectibles, unlike non-collectible coins and ingots. If a coin is “unique” its value lies completely in the eye of the beholder. You may be sold on the idea that a coin is rare, shell out big bucks, and then learn that it is neither rare nor in demand. Oh, and collectibles can be counterfeited and clipped, too.
Good: If a company mines or refines gold, it must own gold. As the price of gold rises, the stock in a gold company should rise along with it. Gold stocks are easy to buy and presumably run by managers who are experienced in their business. Let them worry about costs and storage.
Bad: Owning a stock certificate doesn’t mean that you own any gold. Company managers may or may not be capable of getting gold out of the ground profitably. And while you can presume professional honesty and competence, consider the alternative possibility: Enron. Madoff. WorldCom.
Good: Commodity futures permit the use of leverage: you only have to put up about 10 percent of gold’s value to “own” it. Thus, you can own more gold, faster – and profit more if the price goes higher. Storage, transport and counterparty risk are all someone else’s problem. Futures prices track the cash market almost perfectly.
Bad: The futures markets are designed as price risk management tools for owners of commodities, not vehicles for taking delivery of physical gold. Therefore they constitute another form of “paper” and very temporary ownership. And the same leverage that permits quick profits exposes you to losses that are just as quick. You possess no metal – and are subject to margin calls.
And there are other forms of paper gold. A gold Exchange Traded Fund (ETF) can be purchased like a stock, without the dangerous leverage of futures – but also without possession of the metal. Or you can purchase physical gold, receive a certificate of ownership and pay to have it stored in a secure location. Similarly, you can purchase bullion in an IRA account to shelter any profit from taxes. Again, you pay for storage and don’t possess the gold.
Bottom line: Leave leverage and collectibles to the pros. Possession, price and any ongoing storage costs are key. There are always costs over and above the cost of the metal itself and no form of ownership is best for everyone. Buy gold – but only from a trusted seller.