Rathbun: Precious metalsWritten by Gary Rathbun | | GaryRathbun@PrivateWealthConsultants.com
For the next couple of columns I will cover what affects the price of precious metals and how not to invest in precious metals. Today, I will start with some of the basics.
Hardly a day goes by where I am not asked about buying gold and silver. My answer is usually the same, I think everyone should own some precious metals both in physical form and in investment form.
I make a distinction between physical ownership and investment ownership for a couple of reasons. Today, if a person wants to own physical gold or silver it is usually because he or she worries the economy might tank and leave fiat money worthless. By owning gold and silver, they would at least have something of value to trade for food or other necessities. In this sense the ownership is not considered an investment, but rather insurance against a really bad thing.
When buying physical metals it is important to know what you are buying and how much it is costing you compared to the market or spot price. Most outlets that sell precious metals will charge a premium over the cost of spot. I have seen anywhere from 1 percent over spot to as high as 20 percent over spot. Also, some states will collect a sales tax on the transaction, adding an additional 5 percent or so to the cost.
Additionally, many of these dealers will also discount the price from spot for buying back your holdings. For example, you may buy an ounce of gold (currently trading around $1,700 and pay an additional $49 to $150 premium. When you want to sell it to the same or a similar dealer they will give you $1,700 (assuming that the price of an ounce is still the same) less $49 to $150. This means that the price of gold must increase significantly before you earn a profit.
Sometimes there is a storage fee if you decide to store your metals in a commercial facility, but most of us just use our own safe at home. (By the way, never use a safety deposit box for storage. I will cover this in a future column.)
From an investment standpoint, I usually recommend investing in an Exchange Trade Fund (ETF) to invest in precious metals. There are numerous reasons for using ETFs for this type of investment so I will just touch on a couple.
First of all, a metal ETF will very closely correlate with the underlying commodity without a large premium. There is some cost to an ETF but the internal expense is very small (usually 40 or 50 basis points) and has little impact on the performance of the fund.
Secondly and maybe most importantly, by using an ETF we are able to hedge our position and protect the downside. There are several ways of hedging the position, two of the most widely used are trailing stop limits and option collars. Both of these techniques usually minimize the downside risk of the holding.
Thirdly, it is easy to short our position or invest from the thought of a metal going down. It is easy to short a precious metal on the futures market but there is a whole list of other conditions one must meet to use this venue. Shorting an ETF is easy and it can be done so that it carries very limited risk.
Shorting is a very misunderstood investment technique and is usually associated with “evil speculators” (talked about last time) but essentially every transaction in the investment world contains a person going long and another person going short. No matter what you sell, whether it be gold, an acre of ground or a bushel of corn, you are speculating that you can do something more with the cash than the asset. Investments work the same way.
Finally, there are advisers and pundits who will make the case that a precious metal ETF does not really have the physical metal in a vault somewhere backing up the shares. I have looked into this very carefully and feel very confident that the investments we use are properly backed and secured.
Next time, I will talk about the wrong way to invest in precious metals.
Gary L. Rathbun is the president and CEO of Private Wealth Consultants, LTD. He can be heard every day at 4:06 p.m. on “After the Bell with Brian Wilson and the Afternoon Drive” and every Wednesday and Thursday at 6 p.m. throughout northern Ohio on “Eye on Your Money.” He can be reached at (419) 842-0334 or email him at firstname.lastname@example.org.