Sep 4

Buying diamond wedding rings with gold coins

Gold coins come in two general classifications (i) numismatic coins and (ii) bullion coins.  A numismatic coin has a price that doesn’t relate to its bullion value so   much as rarity and Fourbullioncoins desirability for collectors.  A bullion coin, on the other hand fairly accurately shadows the bullion price. Small bars behave similarly to bullion coins.

Advantages of bullion coins and small bars:

  1. Coins and small bars are generally a liquid market, so you can find sellers and buyers when you need them.
  2. They are relatively accessible to smaller investors.  Coins in particular can be bought with modest amounts of money while bars of 1 kilo (2.2 lbs) start at about $15,000.
  3. Coins are mostly recognizable, which makes them exchangeable for goods in some circumstances.  This monetary characteristic makes them attractive to people who want to take possession of gold as a means of surviving a catastrophe.
  4. Genuine coins have the added endorsement of a government mint that provides a level of guarantee.

Disadvantages of bullion coins and small bars:

  1. The local custody problem.  It is often the case that when gold becomes really valuable gold coin usage is made illegal by governments, or is so heavily taxed and constrained that it is nonsense to use them ‘above the counter’.
  2. There are fakes, and these are usually only spotted by dealers, although there are tools that might help the less experienced.  Dealers rate themselves at spotting fake coins from their surface, but because bars are generally bigger than coins they can be ‘drilled out’.  This obviously illegal activity leaves the serial numbered bar skin behind and fills the interior with an alternate, like lead.  This has a consequence on resale, even by the innocent.  The dealer may not trust assay marks on bars that have been in private hands, and may require an analysis before payment.  Even where the bar is perfectly sound it means the seller may still end up having to pay for the refining.
  3. Next to most types of investment the difference between buying and selling price is significant. On the face of it this can cost 7%, but the reality is usually worse.  Demand tends to come in waves, with the market producing a surfeit of buyers or a surfeit of sellers at any given time.  With a wide spread to play with the dealer will shade high when most customers are buyers, and low when they are sellers.  For example an international incident that encourages gold buyers might set the underlying bullion price at $400 per ounce and encourage buyers.  The normal 7% differential indicates a $28 spread, but instead of being centered on the $400 mark the dealer anticipates demand and makes a spread of $396 - $424.  When things calm down and people liquidate their hoards the spread, even on the same underlying $400 bullion price, will shade to the low side, and the dealer will make a price of $376 to $404.  It appears to be a $28 spread, but the result of being predictable will be an effective spread for the significant majority of $376-$424, which is 12.8% rather than 7%.  These sorts of spreads greatly diminish the probability of worthwhile profits to the investor.  (Although note the considerable advantage for those who trade against the crowd and enjoy a 2% spread.)

Coins and small bars can be an appropriate gold investment method for sums from $100 to $10,000 especially for people whose view is long term and for whom physical possession is all.  In this range it would be typical to suppose dealing costs, delivery and ownership costs in the 10-15% range overall.
 

The Case for Silver bars

Recent strength in the price of silver on the back of France's 'No' vote deserves further attention.  Silver prices have risen dramatically in recent years and we wanted to learn if silver is just along for the ride with gold, or if there is more to the story.

Silver Outperforming Gold
Silver has had a strong run the last couple of years. After rising by 24 percent in 2003, silver had a strong year again in 2004, rising by 13.6 percent and ranging from a low of $5.63 per ounce to a high of $8.29 per ounce. In 2004, silver outperformed gold by 9.6 percent.

Silver’s Excellent Supply and Demand Fundamentals
Today, demand for silver far outstrips supply - 2004 marked the fourteenth yearSilvercoins in a row that industrial demand outstripped silver supply.  The accumulated silver supply deficit since 1992 is now more than 1.4 billion ounces, which has been satisfied through the disposal of government stockpiles.

In 2004 the US government sold the last of its silver stockpile, and the Chinese government sold about 40 million ounces from its stockpile, a sharp reduction from earlier years. With US stockpiles gone and Chinese inventory drastically reduced, the only other known government stockpile is in India, which announced in early 2005 that it would sell off its entire 65 million ounce inventory over the next three years at a rate of about 20 million ounces a year.

Bullish Outlook for Silver Prices
Silver and gold prices are likely to move higher with any continuing weakness in the US dollar.  In addition, the depletion of above-ground stockpiles continues and at some point will be insufficient to feed the silver deficit, requiring higher prices to establish equilibrium in supply and demand.

In short, silver has fundamental strengths that make it extremely attractive as a store of wealth, and the future for silver prices has never been brighter.

Determine risk tolerance
Once the various ways to buy gold are understood, the first-time buyer should decide how much risk they are willing to take.  Of all the ways to buy gold described above, bullion carries the least amount of risk.  Unlike shares on an exchange, bullion will never go to zero.  On the other hand, your expected reward on a bullion purchase is *relatively* limited as it will never exceed the appreciation in the price of gold.

A step up in risk/reward would be a gold Exchange Traded Fund.  Should you pay for your Exchange Traded Fund shares in full, you can expect nearly the same risk/reward profile as owning bullion itself.  However, since Exchange Traded Funds trade like company shares, you could take advantage of margin offered by your broker to turn up the risk/reward dial.  By borrowing 50% on your Exchange Traded Fund purchase, a 5% move in the underlying price would generate a 10% profit or loss.

Mining shares are another step up in risk.  Even if you don't purchase shares on margin, there can still be considerable leverage involved.  For example, a mining company that generates a $10 per ounce profit when gold is trading at $300 per ounce, might realize a $110 per ounce profit when gold is trading at $400 per ounce.  In other words, a 33% increase in the price of gold would generate a 1000% increase in the profitability of the mining company.  And since the share price of a company should, all things being equal, track the profits generated by the company, one could expect the shares to see a similar appreciation.  The company-specific risk of gold shares can be minimized by buying a basket of mining companies available in an index such as the Gold BUGS index (HUI).

At the top of the risk and reward ladder are gold futures.  As detailed in an earlier post, futures contain many pitfalls for a novice and should only be considered by someone with prior experience in futures trading.
 

Diamond engagement rings vs. gold

Disadvantages of gold mining stocks:

The quantity of a mine’s reserves is never accurately known.  Reserves (and their poor relative ‘resources’) are assessed by miners’ core drilling programs that sample a prospective gold seam to measure gold concentrations in the rock.  The amounts discovered in chemical analysis are extrapolated over a wider area to identify the likely reserve amount overall, but there is no guarantee it will be found in mining.  Consequently there is a risk that recorded reserves do not reflect reality.  Human nature gets in the way of accurate sampling, especially in companies whose function is principally exploration rather than the operation of mines.  Prospectors raise money by encouraging investors that there is gold underground, and although a great deal of effort may be made to keep the process honest you only have to overlook a couple of poor rock samples (let’s just call them damaged) to manipulate the likely reserves upwards.  In the end the investor must trust both the geologists and the company’s financial controller – both of whom may have to make the occasional fine judgment.  It is almost always in their interest to err on the side of optimism.  A pessimistic outlook rarely got a mine built.

There can also be unforeseen engineering problems in extracting ore.  These can increase the production costs, and only small percentage increases can eat into the mine’s profitability.

Another issue is that the costs of the mine can be borne in a currency other than dollars – the trading currency of the output.  Exchange rate movements can greatly affect mine profitability by creating currency translation adjustments – both profits and losses.

Perhaps the greatest variable is shareholder sentiment.  Because of the wide attraction of gold shares in good gold markets the shares tend to greatly outperform not only gold, but also any reasonable valuation of the mine’s future cash-flow.  Investors are often not familiar with the yield numbers they should expect on a mine compared with – say – a supermarket, because whereas there is no reason that using a supermarket will wear it out, the mine certainly will be worthless within a few years, once its ore is gone.  So the return on a mine must pay back both the original investment and provide some profit during its life. A 20-year lifetime mine must yield in excess of 5% per annum before it makes any profit for the long-term investor at all.  Few mining shares can do this, so in effect the share price of many mines already discounts a substantial bullion price improvement.

Corporate culture is another problem.  These days many companies (not just mining companies) are run more for the benefit of their managers than their shareholders.  Many managers don’t like paying dividends because it diminishes the cash pile remaining for staff salaries and new corporate adventures – like exploration or takeover activity.  Very few mining companies could be accurately described as vehicles for the straightforward exploitation of underground ores in the interest of shareholders.  Instead the assets can become the playthings of boards of directors whose best interest tends to be served by punting shareholders’ money on opportunities that are sufficiently credible to grant a possible future beyond the current working mine’s life.  In the absence of strict and generous dividend policies shareholders in gold mines are investing in the strategic competence of their board at least as much as in gold.

Gold shares are potentially risky but simultaneously an exciting investment.  They tend to be reasonably correlated to gold prices but typically much more volatile, and subject to many variations that are independent of bullion market forces.

There are far too many of them to keep track of, and anyway individual analysis is well beyond the scope of this site.  Fortunately stockbrokers will usually perform this function willingly, and many of them post their analysis - or at any rate a teaser - on The Gold Report's Analyst Section.

Mining shares might be considered an appropriate gold vehicle investment for sums from $5,000 range upwards, but investors should remember the gearing and invest appropriately less than they would in bullion.  Buying and selling costs vary from market to market. Not uncommon is a spread of 2% (lower for the bigger mining companies) and transaction costs of 1-1.5% each way.  Combined, the trading costs would amount to up to 4-5% of the capital cost for each investment undertaken.