by Dave Kutcher
So, you’ve decided to start saving money for your future. You’ve done your homework, and everything tells you that a well-diversified portfolio of various investments is a smart way to go about your business. The age-old adage of “don’t put all of your eggs in the same basket” seems to make perfect sense, and so as you consider various ways to invest your money, the idea of adding precious metals, such as gold and silver, might seem a prudent plan of action.
In general, the diversification of investments in an overall investment strategy is a good idea. Different asset classes such as stocks and bonds perform differently depending upon what else is happening in the financial markets and having some of your eggs in various baskets means when financial markets cause changes, some of your assets will respond favorably while others are responding in a negative way.
The idea is that you smooth out your aggregated rate of return and manage risk in a way that doesn’t subject all of your money to financial loss at the same time, thereby limiting your exposure in the event of a catastrophe. In this equation, precious metals are considered as one component of diversification that may provide protection against a decline in the value of the paper dollar and perhaps a hedge against inflation.
When considering precious metals in your personal portfolio, it is important you start with understanding some basics on metals.
Precious metals value is made up of two things in some cases; the value of the metal itself, which is easy to measure based upon the ever-changing value per-ounce of the metal, but also something called “numismatic value”.
Numismatic value is something a seller receives beyond the metal price itself which might reflect the markets interpretation of value for something “collectible”. The quality, rarity and demand for your holdings will determine its numismatic value. In other words, a rare coin may bring value beyond the price of the metal itself because it is rare and the marketplace places value on the fact that it is highly sought after for its rarity.
In other cases, it may just be the popularity of a particular coin from a collectible perspective, meaning it doesn’t necessarily have to be rare to have numismatic value … if your choice of metal investment is seen as having value beyond the price of the metal itself, then there is numismatic value to consider.
The thing to be careful of here is that sellers of precious metals place value on these numismatic factors and place a premium on your purchase of the metals that you may or may not be able to recover in the future. In other words, the numismatic value placed on the metals is in the eye of the beholder … as an investor, that means in the eye of someone who might be willing to pay a price to you beyond the value of the metal itself in the event you were to sell your metals to realize your potential profits.
So, at this point you realize there is more to valuing metals than metal prices alone. This is true assuming you are buying metals in some form that potentially can provide numismatic value. There are other ways to buy metals too and the valuation of those metals might be easier to track.
Some people invest strictly in the metal itself relying on the “bullion” value of the metal…in other words, think of bullion pricing as the physical metal pricing itself. Buying bars of silver and gold would be an example of relying on the bullion value of the metal in determining its changes in value over time.
The bullion prices of metals are determined by many factors. Depending upon what metals you are purchasing, you should be aware that markets determine the bullion prices of metals in different ways. Both gold and silver have attractive features, but gold is likely a preferable investment for the average precious metals investor with a larger liquid market driven by investment and jewelry demand whereas silver is more speculative and its value more closely tied to what is happening in the economy.
The price of silver, as an example, is much more susceptible to the economic forecast of our industrial complex than is gold. The reason for that is that demand for silver relies far more heavily on the technological and industrial application of silver than does gold. We use silver in far more industrial applications than you are likely aware.
Additionally, you can invest in precious metals through funds such as Exchange Traded Funds too. In this case you are not physically buying the metals themselves, but investing in funds that buy and sell precious metals and your value of these investments is determined by your share value in the fund. You will not actually have the metals themselves as you might with bars or coins.
Let’s now review some pros and cons for precious metals investing in general before we summarize your considerations for whether adding precious metals to your overall investment strategy is a sound decision to make.
PROS (GOLD):
Numerous options for purchasing: physical gold (bullion, coins, jewelry), gold ETF’s, gold IRA’s, stock in gold mining companies to name a few.
Provides diversification of investment beyond stocks and bonds.
Hedge against inflation: Gold tends to increase during high inflationary periods so it can act as a hedge when purchasing power declines.
Reliable way to store value: Historically gold has maintained value over long periods of time allowing you to purchase, hold and then later exchange the gold for equal or greater value.
CONS (Gold):
No Cash Flow: Gold does not pay dividends or interest so while the value of your holdings may increase over time and allow you to sell it later to generate actual cash, while you are holding it, it does not produce useable income to your portfolio.
Requires Storage and Security: If you are buying actual physical gold you will incur storage, security and transportation costs that you do not have with many other types of investments.
Prices can and will change: Gold has been much more volatile over the last several years than it had been with a longer historical view and your ability to turn price changes into actual profits will depend upon timing in the markets.
Opportunity costs: Purchasing gold during times when other economic factors might be more rewarding can cost you better rates of return than might otherwise be available on other assets.
SILVER (PROS):
Affordability: Silver is more affordable than gold simply due to the price per ounce. With silver prices per ounce currently around $24 per ounce, gold is almost $2,000 per ounce. So, for a small investor, silver may provide a much more viable option to be buying as a bullion purchase.
Various purchasing options: Similarly to gold, you can purchase silver in many forms such as physical silver, silver ETF’s, silver IRA’s as well as buying stock in silver mining companies.
Earning Potential: While silver is more volatile in terms of prices, the increased risk of that volatility in pricing can sometimes yield a greater reward.
Industrial correlation: Silver has many industrial applications which means its pricing is impacted by industrial demand. Demand for silver may increase the price of silver while other precious metals are in decline. (this is a double-edged sword, however)
SILVER (CONS):
Industrial correlation: Just as mentioned above, the price of silver is highly dependent upon the industrial demand for its use. If demand is down, silver prices may be decreasing while other precious metals are increasing in value.
Higher risk: While silver may provide a potential for higher rates of return, the volatility of its pricing presents a much greater risk for an investor.
No Cash Flow: Similar to gold, silver does not generate income through dividends and interest as other investments might do. You are not producing usable income unless you can sell the asset favorably.
Requires Storage and Security: similarly to gold, buying actual silver requires the added cost of storage, transportation and security.
So, is there gold in them there hills for you?
If you are just getting started or are still early on in your investment experience, we would likely tell you to stay away from precious metals. As you grow and accumulate more and more assets you will look to expand your opportunities for diversification into less traditional investment choices which may or may not lead you to precious metals as one of many ways to preserve, grow and ultimately use your assets for your future enjoyment, such as retirement.
Buyers need to be aware when purchasing metals. It is an unregulated industry littered with stories of people who have been taken advantage of. You will be paying a premium to purchase metal, higher if there is numismatic value and less so with straight up bullion purchases, but once you buy, prices will need to rise enough just to cover your premium costs before you have any possibility of gain. When it becomes time for you to use the asset, you will have to rely on the marketplaces demand for your metal and be able to favorably turn that asset into spendable retirement income by finding a buyer willing to pay you what you believe is the value of your metal assets.
We will share a recent story of one of our clients we are working with today just to give you a sense of your risk in this regard. We have a 68-year-old female client who purchased silver coins with a premium deposit one year ago in the amount of $395,000. That same women is trying to move out of that silver coin purchase today and her liquidation value on her coins is being quoted at $165,000. This sale would equate to a $230,000 loss for her, 58% down from what she invested.
This is not a pool you want to swim in if there is any chance you cannot bear the risk of drowning. In this example you need to understand that the price of silver has not fluctuated over the last year anywhere enough to justify the loss in value of her coins … her loss is complicated by a lack of numismatic value that she otherwise thought would be there.
The fact is, there just isn’t enough demand for her coins and that leaves her in a very difficult position in terms of how she can now turn her assets into usable retirement income. While this is not her only asset earmarked for retirement, the initial investment of $395,000 represented almost 40% of her overall retirement funding and now that component is at a 58% loss in value.
This is not a place for beginners. It is not a place for those who cannot bear a loss. It is not a place for those who don’t have a thorough understanding of the marketplace and it is not a place for an investor that doesn’t have sufficient liquidity to cover emergencies in some other way.
If you have amassed substantive assets in the accumulation phase of your financial life and wish to allocate a portion of your savings to something that may provide a hedge against inflation and provide an alternative store of your money, then perhaps a venture down the precious metals lane in the financial markets is warranted.
Bullion is less likely to have surprises and will require less premium costs as you are not paying for purported numismatic value and gold is less volatile than silver in the big picture because it is less dependent upon a strong demand from the industrial /technological sectors of the economy to maintain its value.
All of this being said, collecting coins, both newly minted collections as well as hanging onto Mom or Dad’s old coin collection can be fun. You might even get lucky and find a rare old coin hanging around unknowingly in the change drawer … but don’t go buying metal thinking you’re going to turn a quick profit or even that you will yield significant gains over time. At best you are likely to preserve some bullion value over time in a physical asset alternative to stocks, bonds, real estate and cash.
My name is David A. Kutcher, a retired Marine Corp Captain. My business partner in the lower 48 is Richard C. Scott, CLU, LUTCF. For nearly 40 years we have been helping folks with their personal retirement decisions. We encourage you to make an appointment and get ahead of your concerns as early as is possible. You can catch us on the radio every Saturday morning, “Retirement in the Last Frontier”, 8:30-9:30 on AM 650, Keni Radio. Frontier Retirement, 10928 Eagle River Road; Eagle River, AK 99577, (907) 795-7452
