Not Just for Pirates Anymore: Making Money on Gold

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There is much cause for concern given the current state of our economy. About a year ago, the U.S. underwent a credit rating downgrade by the S&P due to concerns about its spiraling debt. More recently, the Bureau of Labor Statistics is reporting overall unemployment at 8.3% as of July 2012, which is lower than the 9.6% reported for 2010 but still not at the pre-Recession 4.6%. Consumer spending, initially boosted by government stimulus packages in 2009 (and which increased our national debt), has now slowed and stalled. The bottom line: We are not doing well financially.

Traditionally, times of economic uncertainty have lead consumers to save and invest their money rather than spend it. In the past, it was popular to hide one’s cash under the mattress or to invest it in high interest bearing Treasury bills. In the 90’s, people invested (and made out like bandits) in the stock market. These days, however, with government bonds paying a measly 1.56% (for a 10-year bond), the U.S. dollar depreciating like crazy and stocks also tanking, many folks have turned to a different investment vehicle: gold.

The timelessness of gold

For millennia, money (and wealth itself) was equated with gold and other precious metals like silver. Until 1971, the U.S. monetary system was still based on gold. In fact, a vehement segment of the U.S. population believes that, had we not abandoned the gold standard, we would not have encountered runaway inflation and the resulting devaluation of the dollar. However, that is a story for another time. Meanwhile, here are some data, courtesy of Kitco, detailing the price of gold over the last several years:

You might notice that the price of gold has increased significantly since 2007, the last year before the Great Recession began. However, did the price of gold really appreciate or did the value of the dollar simply go down? According to SymmetricInfo, gold is merely a commodity and its value is determined by the exchange rate of the U.S. dollar. If that’s the case, our money may actually have depreciated 50% given that gold’s price has doubled in the last 5 years. Yipes!

Gold as an investment

Because our economy is not out of the backwoods just yet, many commodities experts predict that the price of gold will continue to go up. Personally, I would not be surprised if gold rose to $2,000/ounce following another economic downgrade or scandal. Some alarmists are stating that, should U.S. debt increase to the point where no country is willing to buy it (making the U.S. dollar meaningless as the fiat currency it is), the price of gold could head into the stratosphere at $5,000/ounce. However, even if such an apocalyptic event doesn’t occur, it never hurts to have a small percentage of your money invested in a truly tangible asset like gold.

How to buy gold

Gold is typically purchased in the following ways: mining operations, funds and bullion/coins. Mining operations are most often made available as stock shares in companies such as Eldorado Gold Corp. (NYSE: EGO) and New Gold, Inc. (NYSE: NG). While such an investment strategy does help you earn money when high flyers in the tech sector fall or when there’s a panic on Wall Street, it’s not the same as owning the real thing. Also, your payout from these stocks still comes in the form of dollars, not gold.

Gold funds are purchased either as mutual or exchange traded funds (ETFs). With gold mutual funds, you pool your money with other investors and buy a given number of mutual fund shares. Those shares, meanwhile, might be derived from stocks, bonds, money market instruments, etc. With ETFs, you buy shares of a fund that is publicly traded on a stock exchange. Many gold ETFs hold a significant amount of gold in storage; for example, the iShares COMEX Gold Trust, which is publicly traded on the NYSE as the ticker IAU, holds over 44 tons of gold in storage. However, just like with buying shares in a gold mining company, you do not own gold directly and only collect dividends or monies associated with stock/bond appreciation.

Finally, there is investment in the REAL thing, meaning the glittery stuff you can hold in your hand and even bite if you want to. Gold coins and bullion can be purchased from “brick-and-mortar” dealers (e.g., jewelry stores) and/or banks. Here in Madison, Wisconsin, I’ve been a faithful patron of the dealer Jim’s Coins. Alternately, you can find plenty of gold dealers online, such as the APMEX (American Precious Metal Exchange). Online gold dealers offer several advantages, including a more available and wider selection. They also (though not always) charge a lower commission price over the “spot” price of gold.

Incidentally, what is the “spot”? It is the “raw” price of gold as determined by the exchange markets. This is the price of gold that you will always pay no matter what dealer you choose. Spot quotes, much like stock quotes, change day to day as gold is traded. However, the commission, which is sometimes termed as “price over spot” will differ based on your individual dealer. Thus, it helps to shop around in order to get the lowest price over spot.

I’m definitely in favor of investing in real gold versus shares in a gold mining company, mutual fund or ETF. Should the end of the world (as we know it) come, I’d rather be caught short with actual gold lining my pockets than worthless printed emails stating that I own some part of a gold mine out in Columbia. Furthermore, if the dollar does continue to deflate, how much are my shares going to be worth anyway?

“All that glisters is not gold…”

As with all investments, there are several major scams to watch out for when it comes to buying gold. Here are some doozies:

  1. The hard luck story. The online or real-life dealer promises to double or triple your money if only some hurdles can be overcome with obtaining the gold in question. This was famously portrayed in the case of Tri Energy, a company that swindled 735 (primarily though not solely) Mormon and born-again Christian investors out of at least $50 million. Many of these investors had taken second mortgages or cashed out of their retirement accounts to finance the venture. Tri Energy’s storyline was that a Saudi Arabian prince needed money so he could transfer 20,000 tons of gold currently being held in Israel through Luxembourg and to the United Arab Emirates (seriously, does this even sound plausible?). Anyone who helped this unnamed “prince” move his gold would be rewarded handsomely (up to 1000% of the invested amount). Investors were duped into paying more and more money by occasionally receiving investment “returns”; however, these returns were generated not from the gold in question, but rather from funds supplied by new recruits to the Ponzi scheme.
  2. “Vaulting”: The dealer states that gold is too risky a commodity to send in the mail and offers to “vault” the item for you (has no one heard of shipping insurance?). Instead of obtaining the actual product you purchased, you receive a worthless certificate or some other document stating that you have X amount of gold in Y location. Usually, this location will be hard to reach and/or out of the country. Buyer beware.
  3. Fake coins/bullion. An online dealer offers unusual gold coins and bullion that no one has ever heard of and which are not marked by an easily recognized manufacturer like Credit Suisse or PAMP. You receive your product as promised- only to later discover that the gold is actually an alloy or some other metal. By that time, the online dealer has long since shut up his/her shop and disappeared with your money.

How to best avoid gold scams

When it comes to buying gold, there are several actions you can take to better avoid scams. Here are some words of advice:

  1. Check dealer accreditation. When locating a dealer, be sure to check out his/her store’s rating and accreditation by the Better Business Bureau and the Industry Council for Tangible Assets. If you’re looking strictly for coins, it helps if the business is also affiliated with the American Numismatic Association.
  2. Do your research. Look up the dealer online and link his/her shop to the word “scam”. See what pops up. Also, find out how long a particular dealer has been in business; scam artists typically don’t stick around for very long. If you have any lingering doubts about a dealer, there are online gold forums that you can frequent and where you can ask for recommendations. For example, Kitco offers forums for various precious metal interests. Finally, it never hurts to call the dealer at his/her provided phone number and see if you get through to an actual human.
  3. Choose well-known gold bullion and coin brands. It’s best to select a well-known gold piece and/or manufacturer when working with a new dealer so that your purchase can be easily verified by another dealer or appraiser “back home”. For instance, there’s bound to be significantly more information about the authenticity of say, a common American Eagle than a rare Ultra High Relief 1907 Walking Liberty. The same goes for gold bullion; you’re better off with “name brands” like PAMP, Perth Mint or Engelhard rather than unlabeled bullion or industrial gold.
  4. Buy small. Until you can verify a dealer’s reputation, don’t go buying $100,000-worth of gold from him/her. Instead, purchase the smallest quantity possible and build from there. Also, it never hurts to shop through more than one dealer. This way, you lower your chances of being completely ripped off should, God-forbid, one of the dealers turns out to be shoddy.

What type of gold should you buy?

Pure gold comes in two forms: bullion and coin. Gold investors have differing opinions when it comes to buying either of these forms. Those in favor of bullion argue that it is the cheapest form of gold around, is stamped by its manufacturer and is guaranteed to be genuine. No one can doubt that your one troy ounce bar of PAMP-stamped gold is anything but a one troy ounce bar of PAMP-stamped gold.

On the other side of the camp are those investors that favor coins. The most convincing argument that coin investors offer is that, in addition to your gold being recognized as gold, having it in coin form also makes your investment recognizable as money. Overall, coin strikes are easier to recognize as genuine, while identifying a gold bar as pure gold might require physical and/or chemical tests.

The downside to buying coins is that their price over spot can be $100 or more. Coins that are rare, very old or have significant historical value can cost several times more than their actual weight in gold. By comparison, bullion gold commissions are $40/ounce or under. What’s the best solution to this dilemma? Buy bullion coins.

Bullion-grade coins are a relatively new concept and are perfect for the gold investor (rather than the collector) because their commissions run about the same as those of gold bullion pieces. However, the coins are deemed legal tender and are internationally recognized as currency. Some examples of bullion-grade coins include the Canadian Maple Leaf, American Buffalo and Australian Kangaroo. To qualify as bullion-grade, these coins must be at least 99% gold. The purity of the bullion coin is typically stamped onto its head as either .999 or .9999 gold.

Your golden future

Investing in gold is not like investing in stocks or bonds. It may take years, even entire decades, to see a return on your investment. Furthermore, you may wish to leave your gold collection to your children as an inheritance. Many investors derive pleasure from collecting rare gold (and other precious metal) coins and reflecting on their history. However, in the end, gold is a commodity that can be bought as well as sold. And, unlike other tangible assets such as land or real estate, gold is still the best bet against depreciation and deprivation during hard times.

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