Chapter 7: Gold and Silver
-George Bernard Shaw
A Golden Opportunity
We can look at gold from several angles: as an investment, as a true private currency, and as an industrial product. Because gold has many characteristics, it doesn’t hurt to keep gold consistently in your portfolio.
Gold has, primarily, been a measure of value. If you compare the value of gold against the value of things you can buy, gold will buy the same amount of goods over time. The truth is that gold’s price may change, but its value does not. Therefore, we can say that gold is a measure of value, and paper dollars are just an IOU by our government.
So if you invest in gold, you have principally picked a safe fund to store your money. It is what a bond is often reputed by brokers and government agencies as being, a safe store of value. Bonds are sold to those who want to store value and take less risk. Gold does precisely this over time. Bonds do not. For example, if your bond has a yield of 4%, and inflation is nearly 10%, then your net loss is 6% in purchasing power every year. Further, while the bond yield will not change over time, the inflation rate tends to rise. So it is an accelerating loss that will destroy the returns on the bond.
After all, the government wants to pay off its debt with devaluing dollars over time or risk default. Gold doesn’t have these problems. While it does not have a yield, gold will purchase the same amount of goods over time regardless of the price. And gold, therefore, is really what a bond is claimed to be, but isn’t.
Michael Maloney outlines, in his book, Guide to Investing in Gold and Silver: Protect Your Financial Future, the DOW industrial average of stocks versus prices of gold. Gold has risen over time more than the value of the DOW average. In addition, Michael shows us that the DOW index has fallen against other commodities that may be purchased, such as oil, agricultural goods, and industrial metals. If you have your savings wrapped up in the stock market, then you will lose purchasing power over time, even though the stock market appears to be rising! This happens when the pace of inflation exceeds the return on the stock market. If you had not thought to make this comparison, then you would not realize that a rising stock market could actually result in losses in purchasing power of goods you buy every day.1
So if gold’s value does not change, is it an investment? The answer is both yes and no. Over time, gold retains value but does not build it. However, there are shorter term opportunities to realize gains in gold. Remember that gold’s purchase price in dollars is reflected in the amount of new paper money printed. Right now, gold’s dollar price has risen slower than the amount of money in circulation. There is a delay of time from when circulated money is reflected in prices. The affects of inflation take time and do not occur on all goods simultaneously. This window is still currently open, which means you can make gains by investing in gold. So if you buy it now, you are just receiving a discount.
In addition, as the debt and currency crisis affects countries at different rates, it creates spikes in the local spot prices of gold in those crisis areas.6 There will be arbitrage opportunities for investors during these stages. As European currencies fail, those that figure out how to sell from US and Asia to Europe (by keeping costs low) will make a quick profit in the difference not between an ounce of gold here and an ounce of gold there, but in the relative worth of fiat currencies. Again, because the US dollar is the reserve currency, US citizens will have the most chance of profiting from coming currency failures, at least until the US currency fails. At that time, gold is likely to resume its place as the world reserve currency. Those that hold it will be able to buy stuff. Those that don’t will have to start earning it and be the new working classes.
The second reason why this window is open and has been since the year 2000 when gold really began to climb is that central banks have been able to manipulate the price of gold. You see, in a paper money system, the central bank likely does not want you to realize that they are printing so much that your purchasing power is decreasing over time. Recall that modest deflation increases the amount of goods your dollar can buy over time, but inflation does the opposite. So, the central banks do not want the price of gold to rise in lockstep with the dollar, or the result is that the value of the dollar would shrink in relation to the only true currency, gold.
Therefore, because central banks have been net sellers of gold over the last few decades, the price of gold has remained low. This may be one reason why the US government will not allow an audit of the gold in Fort Knox. It is entirely possible that they have sold most of it to keep the price of gold artificially low while they issued debt and printed money to keep the debt pyramid going.
We are nearing the time when the pyramid will collapse and the true market value of gold will be known. Some have speculated that the price of gold may be $57,000 an ounce when compared to the amount of new US dollars that have been printed. How did we arrive at that number? We compare US M3 (approximately $15 trillion at time of this writing), the broadest measure of the money supply, against the ounces of US gold holdings (8,133 tons) being reported by the US government.
But this may not be quite correct. Other countries have also been running their money printing presses at different rates, and we may not know what the final price of world’s gold reserves is compared to total world paper money creation. But, to be sure, gold’s market value appears to be much higher than the $1,100 range that an ounce of gold is trading at now. The good news is, you still have time to buy gold cheap and benefit from the discount.
Because the debt pyramid must collapse, don’t worry about when it will happen. Know that by buying gold now, you are preserving your wealth while others are losing theirs. By preserving your wealth, you ensure that you will not fall victim to the inflationary destruction wrought by the world’s central bankers.
A Silver Lining
Silver has also been used in the past as a currency. Prior to 1965, US coins were minted with 90% silver. During 1965-1969, half dollar coins contained 40% silver and 60% copper. After 1969, all coins ceased to have silver in them. Shortly after this, people began hording the silver coins and spending the much cheaper copper nickel coins in their place. Indeed, investing in 90% and 40% silver coins is one of the most cost effective ways to collect silver as the markup is lower than on pure silver coin and bar issues.
While silver has been used in the past as currency, silver is also widely used in industrial applications such as in medical equipment, consumer electronics, photography, batteries, and as jewelry and dinner ware. Silver has the following attributes which makes it highly sought out as an industrial metal:
- Highest thermal conductivity of all metals
- Highest electrical conductivity of all metals
- Highest reflectivity of all metals
- Chemical and anti-bacterial properties that make it attractive in medical implements
The various industrial applications cause the percentage amount of silver used to be higher than that of gold. This makes silver much more useful in the market, but also a bit weaker as a currency alternative. Depending on how much is used in industrial applications, the value of silver may swing more often than that of gold.2
Silver is being depleted very quickly. In the 1940s, US silver reserves stood at 5.9 billion ounces. Now, silver reserves are around 50 million ounces. This is a decline of about 95%. World silver reserves are less than 350 million ounces. There is only enough silver in supply for about four month’s worth of industrial demand. Current demand exceeds current mining of the metal, which means supplies will continue to dwindle. Most silver is mined as a byproduct of other mining operations and there are few known silver mines in the world. Therefore, it is difficult to mine enough silver to keep up with current demand. The demand for silver is so great that we can expect the price to rise dramatically in the coming years.
As an investor, silver may be superior at times to gold for this reason. There are times in the market, such as now, that the price ratio of gold to silver is higher than normal. This occurs often when large quantities of gold are traded as a hedge against debt default and excess paper money creation. Silver can be called the “forgotten metal” during these times. But because silver’s value is also partially attributed to use as a currency, silver may be currently underpriced in terms of dollars.
The historic relationship of silver to gold during the last century has usually been sixteen to one.3 From 1900 to 1980, the ratio was in the mid-30s. Since then, it has risen to a high of ninety-four in 1990 to the current ratio of sixty-three. Therefore, if the ratios come back to historical levels, silver may be more undervalued in terms of dollars and may have a much higher upside percentage-wise per ounce than gold does.
For investors wanting appreciation in value, silver is a better bet than many other commodities. When world shortages come to the forefront, the price will launch higher and create wealth for those smart enough to buy the physical commodity now at suppressed prices. Silver prices have been suppressed by massive short positions taken by many large banks. The market will eventually overwhelm the short positions and create a skyrocketing market price for silver. I expect the price of silver to match the price of gold in a relatively short period of time, perhaps by 2020.
Where to Invest in Silver and Gold
ETFs
There are several ways to invest in gold and silver. For most investors, ETF funds are easy to buy and sell. ETF stands for exchange traded fund, which is a type of fund similar to a mutual fund, but with typically lower fees. The fees are lower because the funds are not managed actively by a person, but tend to follow indexes already established in the market. A popular gold ETF is GLD and for silver is SLV. You can research more ETF options at www.etfdb.com. When you purchase a commodity ETF such as GLD or SLV, you are purchasing a share of the issuer’s bullion. You will not take physical ownership of the bullion.
Be careful when purchasing an ETF. Your share is a claim on the bullion that is supposed to be in storage. But it is unlikely, given the amount of metals ETF trading that is done, that actual holdings in ETFs may be only a small ratio of all outstanding shares (claims). Unless the ETFs have been hoarding more metals than are currently known to be in circulation, it is quite possible that there will be very little metal backing them.
The benefit of ETFs is that they are a low cost way to trade the metals without taking physical ownership or paying storage fees.
Options
An option is a contract to buy a given commodity at a given future date. You may have heard of stock options. Commodities options are very similar to stock options, but they involve investing in tangible goods instead of companies.
When you purchase an option, you have the ability to take delivery of the commodity. But most options buyers do not intend to take actual delivery of the good. Only a small portion of options contracts are redeemed for the goods sold each month on the exchange markets.
There are many more options in the market for a commodity than there is supply of the commodity itself. Why is this? In the past, farmers and merchants had a hard time planning their business because market prices of corn, wheat, and metals could fluctuate rapidly in a short period of time depending on factors such as weather and supply and demand. If the current market prices were bid under the producer cost, then producers could not make a profit and may have to dump a portion of their inventory. Using options to bring many more buyers and sellers into the market creates market liquidity which smoothes out the prices of goods over time so that commodities sellers may be able to better plan their business. Most options contracts are simply rolled over into new options when they expire, which is how many more options on a commodity can exist than the commodity itself.
In addition, the actual commodities holders can “hedge” their positions by taking options in an opposite position on the goods they sell. If the commodity price falls rapidly, a commodity supplier with a short (selling option) on the commodity could make profit on his options position and reduce any losses in the actual sale of the commodity in the market.
Sound complicated? It can be for the first time investor. Options involve knowing the factors affecting the markets of the underlying commodities and keeping abreast of changes in the market. Options investing involves risk on the part of the options holder. While there are ways to reduce your risk by buying and selling various options types, options are not a sure way to make money.
If you invest in options for silver and gold, know that these options may help you capture profits on the rise and fall of the metals. But in times of crisis, because there are many more options in the market than the actual bullion, you most likely will not be able to redeem your options and take delivery of the base metals. Therefore, options are for trading, not owning, the gold and silver.
Certificates
In addition to options, investors can purchase gold and silver certificates from brokers. These brokers hold the physical commodity, and the investor pays a fee for storage. These certificates are easily tradable and are attractive to investors.
There is a big caveat to buying certificates. There have been allegations that some brokers did not have enough precious metal to back up their issued certificates. In one such example, Morgan Stanley settled a class action lawsuit for $4.4 million in June 2007 when it was alleged that they did not have enough bullion to redeem against outstanding certificates.4 Morgan Stanley denied the allegations, but one has to wonder why they chose to settle out of court and not try to win the case to prove their reserves publicly.
Bullion – The Physical Metals
I recommend buying bullion because it eliminates counterparty risk. With paper money, the counterparty risk is that the government issuing paper will not inflate its value out of existence and that they will redeem it in some form of actual useful good, such as gold or silver. When you purchase an ETF or certificate for gold and silver, your counterparty risk is that they have the bullion they say they have and that you can get it in a timely manner when you need it.
If our currency were to crash, for example, and you wanted to redeem some of your certificates, then how quickly could the broker get it to you, and how much would it cost when the demand for the gold and silver raises dramatically in the market? If they have all of it stored, then it should be relatively painless. But if they do not and the prices skyrocket, the broker will likely not have the reserves necessary to purchase the actual bullion at the current price. Therefore, your certificates would be worthless.
Think of it this way. There have been vast sums of paper money created in the world. Those who choose to invest in gold and silver through paper options will not all be able to take possession of an equivalent amount of actual gold and silver. Paper options are more dangerous as we get closer and closer to fiat currency collapse.
Dealing With Physical Gold and Silver
Finding a local gold and silver dealer is relatively easy. There are some in every mid-sized town. In many cases, they are also jewelry dealers. So a good place to look is to start by asking jewelry store owners if they know who sells gold and silver bullion.
When you find a dealer, it is important to know a few things before you actually buy the bullion. The first is the spot price. This is the price, up to the minute, for the metals on the open market. Within the spot price are two components, the “bid” and “ask.” The bid is the price at which the dealer will buy the metal from you, and the ask is the price at which you can buy it from them. The difference between the bid and ask is the ‘spread’. This is a built-in profit for the dealers. It can be as little as $1 per ounce of gold and ten cents for silver. But they will almost never be the same price. The spread is passed from holder to holder and everyone pays it.
In addition to the spread, dealers charge a markup. The cheapest markup for gold usually comes on one ounce coins. It can be as low as 1-3%. The markup is often used to cover the cost of minting the coin from the raw metals. The markup on one ounce silver coins, at time of this writing, is usually about 10-15%. If you buy in bulk, you can of course get a discount. For smaller gold coin sizes, such as 1/10, 1/4, and 1/2, the markup as a percentage is higher because even though the coins are smaller, the processing costs of minting a smaller coin are not much different than a larger one.
The markup is negotiable, however, and there is a reason why. Let’s say the coin is minted when gold is $300, and the total cost is $315 for the newly minted coin. When gold rises to $1000 per ounce, you may pay $1050. Notice the markup is higher on the same coin when it is at $1000. The coin did not cost $50 to mint, so some of this percentage markup is profit taking by the dealer. If we consider the dealer’s position, they may have purchased the coin at $1000 and want the 5% return on their investment. On the other hand, they may have purchased it at $900 and therefore have more profit to negotiate with the astute buyer.
So it is not the total cost of minting that is carried forward, but the percentage. If you are a clever buyer, you can often bargain down your local dealer just a bit. This works well if you purchase more than one coin or are a regular customer. In one specific case, I have been able to reduce markups on gold coins by about 50% just by buying regularly from the same dealer. He knows that he will get more profits in the long run by giving a favorable price and having me return more often. It also helps him move his stock more quickly and take profits on his investments in coins.
In addition to local dealers, you can purchase gold and silver online. My favorite is American Precious Metals Exchange, www.apmex.com. The reasons why I like them is they are very competitive in cost, will take multiple forms of payment, and will deliver to an alternate address if needed so that the delivery company does not leave the package on my front door. In addition, I have heard good things from www.kitco.com and www.goldsilver.com, which is Michael Maloney’s website. Great educational videos can be found at www.goldsilver.com.
You can find gold and silver prices easy online. All gold sellers will have quotes, as well as www.bloomberg.com and other financial websites. Before you go to the dealer, be sure to write down the most current bid and ask prices to make sure you are getting the best price on your purchase. Also make sure to take possession immediately if you buy locally. I have seen some dealers agree to sell product and then deliver it sometime later, often stating their costs went up and they had to adjust your price. This is not an ethical practice, in my opinion, because all bullion dealers cope with moving prices. They profit when they move up and lose when they move down over several days time. If the dealer does not have bullion currently in their possession, they should be honest with you and request you come back again.
What Happens When our Metals Become Currency?
Many people say gold and silver bullion is not practical. How do you use coins to pay for online transactions, for example? How do you ship a gold coin to pay your mortgage payment for a lender in another state? The answer is that gold is as practical as paper dollars and nickel copper coins.
There are already services that allow the use of credit cards against an account in gold.5 The way it works is gold is deposited with the bank, and passing of gold to the merchants is handled for the buyer. This same process is already done with cash, which is electronically credited to merchants’ accounts and not mailed by the bushel. The net cash amount from all transactions is then moved each period. Gold can be handled in the same manner, where all net gold from all transactions is moved periodically. Checking accounts can be created for gold-based bank accounts. There is no difference other than the fact that your funds are in gold instead of paper currency.
If you want to pay cash, 1/10 of an ounce of gold, which is very light weight, would be equivalent to about $100 at today’s rate, which will rise significantly in the future and cause each denomination of gold coin to be much more powerful. For smaller denominations, we can use silver coins no bigger than coins we already use today as cash. Using gold as currency is no less burdensome than using cash!
So what would prevent the debasement of gold coins as seen in Roman Times? Technology has come a long way. It is very easy to take the weight of coins to determine their purity. Chemical tests, also very inexpensive, can be used to test the content and purity of coins. The integrity of each mint stands in the quality of the coins it produces. With many mints worldwide producing gold for the market, one mint debasing would not upset the balance of the market if the debasement is discovered relatively quickly. The corresponding value of the debased coin issue would be adjusted based upon the total gold content. Given the technology available, it should be easy to detect and inform via the Internet.
In desperate situations, governments could openly debase their currency and force their citizens to accept the coin. But because physical possession of gold is hard to regulate because gold is a true private currency, trade in the open market would adjust for the reduced value of debased coins. Government would only be able to enforce usage of debased coins in collections of taxes and fines. In that case, a citizen could purchase debased coins and intentionally pay government debts with them while keeping the purer coin issues. The government would not be able to pay their debts in debased coinage without the objection of foreign markets. Because our economies are global, global markets act as the biggest deterrence to a single coin debasement. The overall market would fall back into equilibrium.