Ways of Gold Investing

Today we discuss a bit more about investing in gold. I mentioned before it's a great hedge against inflation and overall market turmoil.

Well, as we can see today from Lehman Brother's unexpected fund raising efforts ($6 billion, anyone?), the US capital market confidence is sinking with every large bank's latest PR statement saying how there isn't a problem at all. Doesn't this sound awfully similar to Bear Sterns?

While it's great to have gold-related stocks, some experts recommending 5% of your porfolio in actual bullions.

Bullions

A metal is deemed to be precious if it is rare. The discovery of new sources of ore or improvements in mining or refining processes may cause the value of a precious metal to diminish, as in the example of aluminium, which was considered a precious metal before the development of the Hall-Héroult process made it possible to extract aluminium on a large scale. The status of a "precious" metal can also be determined by high demand or market value. Precious metals in bulk form are known as bullion, and are traded on commodity markets. Bullion metals may be cast into ingots, or minted into coins. The defining attribute of bullion is that it is valued by its mass and purity rather than by a face value as money.

Many nations mint bullion coins, of which the most famous is probably the gold South African Krugerrand. Although nominally issued as legal tender, these coins' face value as currency is far below that of their value as bullion. For instance, Canada mints a gold bullion coin (the Gold Maple Leaf) at a face value of $50 containing one troy ounce (31.1035 g) of gold — as of September 2007, this coin is worth about $737 as bullion. Bullion coins' minting by national governments gives them some numismatic value in addition to their bullion value, as well as certifying their purity.

The level of purity varies from issue to issue. 99.9% purity is common. The purest mass-produced bullion coins are in the Canadian Gold Maple Leaf series, which go up to 99.999% purity. Note that a 100% pure bullion is not possible, as absolute purity in extracted and refined metals can only be asymptotically approached. Usually a bullion coin contains a stated quantity (such as one troy ounce) of the slightly-impure alloy; the Krugerrand is unusual in containing one troy ounce of actual gold, with the impurity making the coin heavier than one ounce.

One of the largest bullion coins in the world is the 10,000 dollar Australian Gold Nugget coin minted in Australia which consists of a full kilogram of 99.9% pure gold. There have been a small number of larger bullion coins, but they are impractical to handle and not produced in mass quantities. China has produced coins in very limited quantities (less than 20 pieces minted) that exceed 260 troy ounces (8 kg) of gold. Austria has minted a coin containing 31 kg of gold. As a stunt to publicise the 99.999% pure one-ounce Canadian Gold Maple Leaf series, in 2007 the Royal Canadian Mint made a 100 kg 99.999% gold coin, with a face value of $ 1 million, and now manufactures them to order, but at a substantial premium over the market value of the gold.

So now that you know what a bullion is and where you can find it (local exchange shops and bullion place), what other type of gold investments are there?

Below is a primer on Investing in Gold that I dug up from archives. Credit to the original writer from a long-running traders-board I frequent. Some interesting tid-bits I've bolded. One thought especially I thought is worth mentioning...

Bullion and mining stocks parallel each other over time, although it may sometimes lag each other.

This is a great point I will elaborate on in my future posts.

Investing in Precious Metals – a primer

First of all, what’s an investment and what’s speculation. From my perspective, I consider a small holding of gold (more specifically precious metals) as an investment. It’s what I consider a ‘core’ holding. By small, I mean 3-5%. More than this is speculation and while speculation is fine, you need to be certain that is your intent.

I consider a small holding of precious metals as a core investment for several reasons. It serves, in many cases, as a portfolio diversifier; it is well known as a hedge against inflation; and, it’s also the number one investment in case of ‘black swan’ or Y2K type events such as war, terrorist attacks, and in general outsized uncertainty. Lastly, in recent years it’s been moving opposite the U.S. dollar. To the extent you feel the dollar will continue to drop relative to other currencies and ‘real stuff’ largely due to the twin deficits, but also because our trading partners are so $ flush, they’re starting to seek alternative investments, you will want to own some.

As for speculation, that’s a subject of personal taste and investing tactics. Some approach this from a fundamental perspective, while some from a technical perspective. I’m bullish for the longer term on precious metals for both reasons. Fundamentally, most bull markets in the natural resources (including precious metals) last for years. This is because of the nature of the beast. If the price of gold goes up, the lag time before new supplies can come to market is measured in years. It’s not like automobiles, where they can add another shift and produce more next week. With mining, you have to explore, discover, test, build refining plants, obtain all your permits, and then ship the product to market. This is true for all extractive commodities. Add to this the twin deficits and excessive amount of currency being the precursor of inflation. Further add that our trading partners hold so many dollars that they’re starting to look for alternative investments. From a fundamental perspective, these all point towards a long term bull market in the precious metals.

From a technical perspective, the current bull market began in 2002 and since then the gold index has not dipped below its 200 day moving average.

There are many ways to invest in gold – mutual funds, ETF’s, individual mining stocks, futures and the actual bullion itself.

Mutual funds that invest in the precious metals include natural resource funds, precious metals funds and some types of ‘defensive’ funds such as hard currency or Permanent Portfolio (PRPFX) type funds. With each of these funds, you need to do your research and determine exactly what they own. The easiest place is Morningstar using their Portfolio selection and Top 25 Holdings choice. Most mutual funds investing in the precious metals do so by owning shares of mining companies, although some own a little bullion. There are exceptions, such as the defense funds above that invest mostly in bullion.

Probably the least risky way to invest in precious metals is with a good broad based natural resource fund. These funds invest in energy, base metals, timber, and among other things, precious metals. A couple of examples are Price New Era PRNEX and US Global PSPFX.

Then there are precious metals mutual funds. With these there are pure play gold funds and true precious metals funds. The former only invest in gold mining stocks, while the latter also invest in silver, platinum, palladium, copper, etc. In all honesty, the vast majority of funds in this sector invest in all of the precious metals to a greater or lesser degree. First Eagle FEGIX is the only pure play gold fund I found while in the precious metals category, there are dozens. Examples include Vanguard VGPMX, Midas MIDSX, US Global UNWPX, Rydex RYPMX, Tocqueville TGLDX, etc.

In recent years, there has been the onset of ETF’s, or Exchange Traded Funds. These are sort of like mutual funds but trade like stocks. There have been some introduced that invest in bullion. These are primarily gold, but also silver. Gold ETF's include GLD, IAU, GDX, while silver has SLV. Note that there is also a metals and mining ETF XME, which includes base metals.

A word of warning: Bullion ETF's have been determined by the IRS to be ‘collectibles’ and as such their capital gains are taxed at 28%. This is unlike mutual or closed end funds which are taxed at 15% for Long Term Capital Gains. This means you want to own a bullion ETF tax deferred account and NOT in a taxable account.

One last similar category that needs to be mentioned is Closed End Funds. There is a fund, the Central Fund of Canada CEF that invests in gold and silver bullion in about a 60/40 mix. This fund has NOT had an adverse IRS determination to date, so it’s still taxed at 15%.

Mining stocks provide the most leverage but are tied to the overall equity market. Bullion and mining stocks parallel each other over time, but often lag each other, sometimes by a significant amount. In this arena, the most leverage is with the smaller companies, but they also carry the most risk. With individual mining stocks, you can target a specific precious metal such as platinum or palladium and many actually mine more than one precious metal (e.g. Freeport-McMoran FCX is copper and gold).

Lastly, for those that wish to actually own some of the stuff, you can buy bullion. In large amounts, this is normally warehoused and insured and you don’t actually take possession. In smaller amounts, folks buy various bullion types and keep them in a safe deposit box or safe. The cheapest form is with plain vanilla bullion types such as rounds (coin like disks) or ingots. By cheapest, I mean that they sell for closest to the spot price. With gold, platinum and palladium, you can buy 1 ounce ingots or rounds and fractional sizes, such as1/2, 1/4, and 1/10 ounce sizes. With silver you can buy ingots and rounds in 1, 10 and 100 ounce sizes. The one caveat with buying plain bullion ingots or rounds is that they should be stamped and marked as to weight, fineness, etc. Indeed, you’re better off going with one of the major producers such as Engelhard, Johnson-Matthey, or Credit-Suisse as these are easier to sell. Also, as with most things, there are volume discounts meaning the more you buy at one time, the cheaper (closer to spot) they are on a per ounce basis.

You can also buy actual bullion coins issued by many countries. These include the U.S., Canada, Australia, South Africa and many others. Bullion coins will have a greater premium over the spot price, but because they are ‘official’, they can be much easier to sell. Bullion coins come in two basic varieties – Proof and Uncirculated. The former are special coins made for collectors and carry an even higher premium than uncirculated. They make great gifts, but are a terrible way to buy bullion. Bullion coins should be the uncirculated variety. Gold and platinum can be had in 1, 1/2, 1/4, and 1/10 ounce sizes while silver come in the 1 ounce ‘silver dollar’ size. In this category, the American Eagle series is the primary U.S. offering. While these have a higher premium than some of the other national offerings, they’re very easy to buy and sell.

Lastly, you can buy ‘junk’ U.S. silver coins. These are dimes, quarters, and half dollars from 1964 or earlier when they were 90% silver. These are normally sold either circulated or uncirculated and by the ‘face value’ of the coins (e.g. $50, $100, $1000).

As for futures, they’re a subject beyond my understanding, and can be very complicated. I would suggest that this is NOT an arena for the novice.

Web sites of interest are:

www.gold-eagle.com - great commentary

www.kitco.com – current spot prices

www.apmex.com – good source for buying bullion in its various forms

Note that these are all sites that are bullish on gold and the precious metals so their commentary may be biased.


enjoy,

rono