Equities falling, gold rises to $950, silver past $18

Posted on 05 July 2008 with no comments from readers

You would think equity investors might be getting the message now with most global stock markets entering bear territory. At the same time gold has broken out again and is heading up. Gold touched $950 an ounce last week and silver ran past $18.

The stage is set for a spectacular advance for precious metals, perhaps within the next couple of months. Gold will pass the $1,000 as in March and then investment demand will drive prices to $1,200. Equities are toast, precious metals are the star alternative asset class now.

This column today will consider the mechanics of investment in gold and silver for the average investor. I have received many enquiries from readers asking how to invest in precious metals, and have not really addressed this issue in any depth before. It is not as simple as might be imagined.

With inflation rising all over the world, the number one concern among investors is how to protect their investments from inflation, or even how to profit from it. Traditionally precious metals have always been the answer. Schroder’s Alternative Solutions Gold and Metals Fund that was launched in Hong Kong last week expects gold prices to hit $5,000 an ounce in this environment.

Indeed, in the last period of high oil prices and surging inflation in the 1970s gold prices moved from $35 to $850 in a decade, with the strongest upsurge post 1978. And silver managed an even more spectacular rise to $54 in 1980 which still stands well above $18 an ounce today. But if you accept the bull case for precious metals and inflation then how exactly do you invest?

One approach is to go down to the Dubai Gold Souk, or your local bullion dealer, and buy gold coins or bullion. Dubai has a very attractive set of precious metal coins minted with Sheikh Mohammed bin Rashid Al Maktoum on their faces, and the premium over the metal cost is small.

The problem with coins and billion is security. Personally I do not like having anything valuable lying around my villa, let alone gold and silver. In some countries people like to bury gold and silver in their gardens but that would not be practical in a country like the UAE with expatriate gardeners to uncover your assets.

Buying bullion deposits with a receipt to say what you own is a good alternative, provided that you can have one hundred per cent confidence in the vault’s owner. In the 1970s there were several unfortunate cases of vaults in private hands that proved to be empty when their owners came to take possession of their metal.

That is one reason to favor a government-owned depository like the Perth Mint which is one hundred per cent owned by the Government of Western Australia. The Perth Mint has a well established system of depository receipts for allocated and unallocated precious metals.

The unallocated metal has a promise from this state-owned institution to convert the metals into bullion on demand, although in practice there may be a wait of a few weeks. Allocated metal is always instantly available but attracts an annual storage charge. Investors therefore have to decide whether they think a state-owned mint is likely to go back on its promise and invite legal actions, or prove a trusty and low-cost option for owning precious metals.

My other favorite option for retail investors who are not buying by the ton and want exposure to precious metals without physically possession are Exchange Traded Funds. Purists will tell you it is safer to buy physical metal and build a vault in your house. But I have to argue that ETFs are most likely much safer for the average person.

All you do to invest in an ETF is to either go to your local stock broker to buy them, or you can easily set up a simple Internet brokerage account with a blue-chip firm like Internaxx Bank in Luxembourg. To buy gold you have some choice but GLD is the biggest ETF and SLV offers the same for silver. You then buy and sell an ETF just like any share, and the money is invested in the precious metal at very low cost to the owner by the ETF managers.

Now purists will again tell you that just as in the Perth Mint unallocated gold investment, you have only a promissory note with an ETF. But again major financial institutions are behind the ETF management and are highly unlikely to fail, and perhaps it is far more likely that your home would be robbed if you have gold and silver under the carpet.

There are also arguments about the liquidity of ETFs. Could they really pay out if all the holders suddenly decided to exit? Again how likely is the smaller investor to be caught out by this, and would a systemic failure cause anything more than a delay in processing withdrawals?

If you want to spread your risk then you could consider doing both ETFs and a bullion deposit. This is of course just a practical guide on how to buy precious metals and store them without having to worry about security issues. There are other ways to gain exposure to precious metals.

You could buy a futures option to buy metal at a certain price on a certain date in the future. You could buy a diversified gold fund. You could buy shares in large gold and silver producers. Or try you luck among the junior explorers and miners whose share prices have become very depressed by short-sellers recently, and are overdue for a short-covering rally.

But these financial instruments all come at a risk premium to the physical metal, although ironically the safest way to hold physical metals is indirectly through depositary receipts and ETFs. For small sums, however, a few of the Sheikh Mohammed coins are very easy to buy and sell.