Purchasing or Investing in Precious Metals like Gold and Silver: How and Why

The most recognized precious metals are Gold, Silver, Platinum and Palladium. Gold and silver are the most liquid and easiest to acquire and dispose of in any form. There are two primary forms that can be acquired, physical and non-physical.

• Most people probably have some form of jewelry in their possession. Jewelry usually has the precious metal content stamped on the underside or another indiscriminant place. Gold weight is measured in carats, with 24k being 99.9% pure and 14k 58.5% pure. Silver jewelry tends to be sterling or 92.5% pure. The reason for jewelry having less that 99.9% purity is that precious metals are soft and can be easily bent or scratched unless combined with a more durable metal such as copper. Precious metal jewelry tends to be priced at a significant premium to the melt value of the underlying precious metal. The reasons for the premium are two things, utility value and uniqueness. The utility value of adorning oneself with an object that makes them more attractive or appear more affluent adds a premium.  The value of uniqueness or craftsmanship that separates it from other jewelry made of the same materials can add a premium.

• Silver is a natural biocide and has been crafted into food utensils for hundreds of years. Silverware can be plated, weighted or Sterling. There are industrial processes that allow stainless steel or brass utensils to be plated with several nanometer thickness of silver. Plated silverware is the cheapest form and usually will not sell second hand for significantly more than regular utensils. Weighted silverware is when solid pieces of lead are incorporated into hollow areas to achieve weight or balance. Examples of weighted silverware are lead filled handles of knives or lead filled bases of plates or candle holders. Finally there is Sterling Silver, which by law must contain a minimum of 92.5% pure silver weight and is usually stamped with “925” or “Sterling” designation.

• Most nations and empires throughout time have incorporated silver and gold coins into monetary circulation. As nations mature and become burdened with social programs and national defense they tend to gravitate towards a system of Fiat Currency. Fiat takes hold when newly circulated coins have less precious metal content than the coins that preceded it. Eventually, gold and silver are phased out and replaced with copper and paper. The reason for the gradual change is due to government spending beyond the taxes it brings in. Since precious metals supplies are finite, they cannot be created at will. Paper promises backed by the faith and credit of the nation are issued as legal tender to facilitate excess spending. In the United States, dimes, quarters, half dollar and dollar coins minted 1964 and prior years have 90% silver content. Gold coins of 21.6 carats were widely circulated (among those of affluence) prior to 1933 and had face values of $5, $10, $20. Back then, the face value of the coin was pegged to the actual value of the precious metal content of the coin. Domestically the United States went off the Gold Standard in 1933 and internationally in 1971. Virtually all coins composed of precious metals are valued at many times the face value on the coin. By going off the Gold Standard, The United States no longer redeemed gold and silver certificate bills in exchange for actual gold and silver coins.

• Precious metal bullion comes in many shapes and sizes. Bullion can be refined and distributed by any entity that has the resources, capabilities and complies with certain standardizations. The most common shapes are round like coins or bar shaped like chocolate.  Bullion can weigh as little as a gram or as heavy as 1000 troy ounces. The weight and purity are always stamped on bullion. Some brands of bullion are more recognized and therefore trusted more than a generic bullion brand and can sell for a higher price for an equivalent weight and purity. Sometimes it may be worth the extra premium to have a greater number of comfortable potential buyers than a fewer number of skeptical buyers.

Non-physical precious metals products known as “paper” are securities instruments that derives its price based on the price fluctuation of the underlying precious metal.

• A precious metal ETF (Exchange Traded Fund) is an investment vehicle that’s sole purpose is to store precious metals or equivalents and issue shares in the investment vehicle to investors that can be actively traded on a stock exchange. Popular precious metals ETFs such as GLD, IAU, SLV and SIVR tends to track the actual price of the underlying precious metal. The trustee of the ETF charges a small expense fee for managing the security instrument. In addition, custodial charges are levied for storage and safe keeping of the precious metals. Investors can buy or sell the ETF shares in any standard brokerage account and pay the same standard commission as trading a common stock such as Microsoft. Many investors find this method of precious metals investment extremely convenient as they do not have to pay hefty delivery charges and worry about its safe keeping. As a caveat, there have been concerns as of late as to the actual value of physical precious metal held by the investment vehicle versus the NAV (Net Asset Value) of the Investment vehicle as well as the exact meaning of precious metals “equivalents”.

• Investors can buy the common shares of publicly traded mining companies in their brokerage accounts. Companies such as Barrick Gold, Ashanti Gold and Newmont Mining are in the business of securing land and mining rights in search of valuable minerals all over the world. Nowadays, precious metals are more often a byproduct of mining for industrial metals such as copper, lead and zinc. Since the most accessible precious metals have already been mined through the millennia, the most cost effective way to extract less accessible supplies are through the mining of other minerals. As a caveat, many publicly traded miners have been known to hedge out their production of precious metals decades out and may not benefit from the rise in price. Recently, Barrick Gold has issued more stock to the public and plans to use the proceeds to buy back the hedges of $300-400/oz gold they sold almost a decade ago. Barrick sold out a portion of their future production, locking in a price that they thought was fair at the time.

• Sophisticated non-physical precious metals securities come in the form of Futures, Forwards and Options. These investment vehicles are in the realm of institutional investors, producers and end consumers of precious metals. Futures and Forwards are obligations between two parties to exchange for a specified amount, a commodity on a specific date. An Option contract is the right exchange for the obligation if the holder so desires. Options usually have to be “in the money” to be exercised. Futures are a leveraged security instrument and require as little as 5% down to facilitate a transaction.  If precious metals prices are climbing, end users such as Tiffany’s and Intel may buy futures contracts to offset any potential future price rise in a commodity required for their products. Producers may sell contracts to insure a minimum price they will receive for their commodity in the future. Most of these contracts are cash settled near the end of the life of the contract. For instance, if Tiffany’s management believes gold prices will be 20% higher in 12 months, they will lock the future price one year out. If they were right on their assumption, then one year later they will cash settle the difference in the cost of the contract with the present value. They can go out in the spot market at purchase gold at the higher prevailing price since they received proceeds to offset the additional cost. This model is convenient since Tiffany’s doesn’t have to lock up significant amounts of capital to buy and store the gold now to guarantee the current price for its future needs. A small fraction of Futures and Forward contracts are delivered at expiration. The producer, instead of cash settling the contract at expiration, arranges to deliver the physical commodity to the purchaser of the contract.

Many individuals dip their toe in precious metals through what’s known as Junk Silver. They go through a huge old coin jar in search of dimes, quarters, half dollars, and dollars dated 1964 and before or foreign coins that may have had silver content in them. This process is tedious, but can be rewarding. U.S. coins consisting of 90% silver currently trade at 12 times face value (as of 3rd Quarter 2009) and can even trade for more if it is rarer (key date) and/or in mint condition. It’s nice to find an old dime that someone will readily purchase for $1.20. Many try their luck at a local bank by purchasing rolls of coins and sorting through them in search of silver. Those with experience say that half dollars have the highest probability of finding silver. Halves have the least circulation and while 90% silver coins were phased out in 1964, from 1965-1970 and 1976, half dollars contained 40% silver.

Individuals more proactive with regard to wealth preservation acquire internationally recognized coins in bulk from National Mints or reputable dealers. Coins  such as The U.S. Silver American Eagle, Gold Double Eagle, Canadian Maple Leaf, Austrian Philharmonic or the South African Kugerrand are a few. Coins made by National Mints tend to sell at significant premiums to spot price. They are harder to counterfeit, are made to the highest of standards and are the most intricate/visually appealing.

There are those that champion the notion that some form of Gold Standard will reappear in the near future. The spectacular collapse of the credit bubble has shown incredible vulnerabilities in the Fiat Currency system. In early November the Central Bank of India purchased 200 metric tons of gold from the IMF near record high prices. This surprised many because they assumed that China would be the obvious buyer since they have expressed concern with regard to the trillions in dollar denominated assets they currently hold. The BRIC countries inducted into the G20 will be a net buyer of gold for the foreseeable future.

Investors of precious metals have to remember first and foremost, precious metals are a store of value. Gold and silver tend to hold relatively the same value or purchasing power over long periods of time. Supposedly during the time of the Roman Empire a premium toga, hand crafted leather belt and sandals cost the equivalent of a 1 oz gold coin. Before the end of the domestic Gold Standard in 1933 a nice suit, hat and shoes cost about $20, or a 1 oz gold coin. Today an ounce of gold is worth about $1,100 and would probably be able to buy you a nice suit, hat and a pair of shoes. Many cite that appearance of price increases are the result of the increase in Fiat Currency supply. Inflation is when the money supply is expanded faster that the products and services available for purchase. The increased money overwhelms the supply of products and services and causes price increases. In the early 1980’s the runaway inflation caused gold and silver to reach stratospheric heights as investors clamored to find a way of preserving the buying power of their assets.