Sunday, July 10, 2011

Does the Glitter have a little Tarnish?

I can take no credit for this blog idea. It came as a result of a discussion with a client. That client sent me an e-mail saying he was thinking about selling out his equity funds in a brokerage account and using the proceeds to purchase gold. He was very concerned about what might happen with the debt ceiling if congress and the president can’t agree and we go past August 2nd with no settlement.

I want to interrupt this story for just a moment. I have grave concerns that while the leadership may come up with a deal it is no guarantee that the full house and Senate will vote to agree with the leadership. No one is talking about the possibility that the plan might not be confirmed. The president and both parties leadership agreed on a plan to deal with the financial crisis three years ago but do you remember the House didn’t carry the motion. We have a Republican controlled house with a lot of Tea Party congressmen who may vote the bill down.

Meanwhile back to our story. My client is concerned about inflation, the falling value of the dollar and the possibility of default on government paper. He feels like he needs some protection and buying gold will give him the ability to pay for food and other necessities. So he ended his note to me asking me what I thought about his idea, I did a great deal of thinking and decided that all of you could perhaps benefit from my thoughts.

My most immediate idea was to suggest the GOLD Exchange Traded Fund (ETF) IAU. The price was just over $15 on this past Friday. The ETF is a way to own physical gold on a shared basis. I sent my client this first idea and he came back to me that he wanted to own the bullion not share in a fund. So, I went to work to see what I could do for him. My research showed that bullion was the lowest cost to own. I found the non- numismatic coins have the least costs and the highest liquidity. So, I concluded that the non-numismatic American Eagle coin has the most liquidity and it is legal tender,  sort of. At the time of this posting the spot price for gold was $1,541.60 and the best price I could find on the web for a one ounce American Eagle coin was $1,895. So the coin has a 20% premium to the spot price of gold. Seems a little rich.

Next I went to to see what they had to say about the cost to buy and sell gold. I did a little deep diving on the site on the risk and disclosure section there is a subhead called Our prices and it says the following: “There is a price differential or "spread" between our selling price (the "ask" price) and our buy-back price (the "bid" price). This is often referred to as a "transaction cost." A typical spread on our most common bullion coins (e.g. Canadian Maple Leaf or South African Krugerrand gold coins) may range from approximately 5% to 20% depending on the coin though spreads may increase based upon market conditions, availability and demand. Our spread on semi-numismatic coins, rare or numismatic coins and rare currency currently ranges from 30% to 35%. To illustrate how this spread works, consider the following example. If the spread on a coin is 35% and Goldline's ask/sell price is $500 for the coin, then Goldline's bid/buy price is $325. Your coin must appreciate more than $175 to earn a profit. If you choose to sell your coin back to Goldline, you must also pay a 1% liquidation fee. Purchases of less than $1,500 are subject to a small lot fee of $15.”

If you buy gold for $1,545 and the American Eagle is selling for $1,895,  gold  must rise to almost $1,900 for you to break-even. All the time it takes for your investment to break even you will be making nothing, no dividends. Now let’s go back to the question of paying for things and I’m going to be a little absurd. You walk into the quickie mart to buy gas and coffee. Are you going to give the guy behind the counter an American Eagle? I don’t think they have a slot in the cash register for American Eagles. Is he going to give you gold in change or American dollars? My guess is American Dollars which just what you are trying to avoid. Most likely you will have to go to a coin store and sell your coin for dollars if they are open when you need to exchange and they are buying the day you need to sell.

Now the next issue is what do you do with these American Eagles once you own them? Do you have a safe installed in the house to keep them secure? In the case of this client I know they have two homes. Will they get a safe in each house?  Will they carry the coins in the car as they travel and take it into the hotel room or put it in the hotel safe? My guess is that they would want to substantially increase their homeowner’s policy for the amount of gold they own. I don’t know how much it costs to insure say $150,000 in gold coin or if the insurance company will even insure that amount of gold.  Perhaps you take them to the bank and put them is a safe deposit box. That would work as long as the bank is open when you need to get your coins.

I’m not trying to discourage you from buying gold. In almost 40 years in this business I have seen many gold waves come and go and many people get burned. In our example you need gold to move $300 just to break even not counting insurance, taxes, or transaction fees. Buying gold should not be viewed as an investment but as a hedge or insurance. You buy insurance on your house and even if you never have a significant claim, was it worth the insurance? Yes.

If you are looking at gold as an investment then I believe there are far better ways to invest than in gold.

Dan Perkins 

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