Wednesday, September 07, 2011

Buy Gold and Silver! (Part 3)

Why you must buy gold and silver in turbulent times
Vijay L Bhambwani
Tuesday, October 4, 2011
The current scenario in the global investment landscape can at best be summed up as ‘precarious’. Investors have a tough task laid out in front of them that calls for capital preservation as their primary goal, with capital appreciation as a secondary objective.
The modern portfolio theory has clearly proved through countless research papers that investors who manage to walk out of relentless bear markets with their capital (investment float) largely intact, have a sizable advantage over those whose portfolios suffer erosion and need to come back to ground zero (breakeven) before yielding alpha (profits) in following bull markets.
While equities, as an asset class, can undoubtedly be relied upon to beat inflation over the long term, they provide little protection during the actual bear market. My personal experience in equity markets since 1986-87 tells me that equity prices witness large-scale attrition in high inflation periods, like we are currently experiencing, and provide almost no place to hide.
In a punishing bear phase, you only have the option of deploying funds in stocks that will at best fall less than the benchmark indices. While this “relative out-performance” is fine for high net worth individuals (HNI) and “buy only” institutions, the retail investor undergoes the horror of absolute returns that are negative. Try paying your electricity and telephone bills with relative returns alone and you know what I am getting at!
Are gold and silver a ‘safe’ haven?
The answer is a confusing yes and no! Yes, because high inflationary periods imply that commodities are a lot more “honest” to an investor and actually appreciate in such turbulent times, and no because in the market place, the price rules supreme and your returns are dependent on the sole factor of buying at the right price. Many technical studies help us gauge the appropriate time to invest in bullion, equities, ETFs and currencies.
The primary yardstick is the age old system of “range expansion”. The technician relies on price charts to track periods when the prices of the underlying asset are moving in a quiet, measured and lower beta (volatility) calibration.
Any “breakout” of such a measure of routine acceleration (rate of change) should alert the trader / investor that the outlook for the underlying asset or the market as a whole is changing gears. It is then a matter of being nimble footed to latch on to the moving bandwagon of prices and riding the “waves” or bull / bear phases.
In the current scenario, avid bullion investors will break apart the price volatility of gold and silver into two phases - pre -August 2010 and post -August 2010. While silver was trading at close to Rs30,000 / Kg, gold was trading steadily at Rs 18,000 / 10 gms before August 2010. The price acceleration in both these precious metals has been swift and parabolic at times. The sum and substance of the argument is that an investor should deploy money when sanity prevails in price patterns rather than chase uptrend for the fear of feeling “left out”. Case in point - any investor who bought silver in the latter half of April 2011 saw a price erosion of up to 30 % within a matter of three weeks.
Where are we now?
Both silver and gold are consolidating after a period of high volatility and parabolic price rise. The probability of short -term weakness should not be ruled out. While the larger scheme of things indicate that the uptrend is by no means fractured, market mechanisms are attempting to “shakeout” the weaker hands by extreme price moves that result in decisions that are more emotional (fear / greed driven) than logical.
Typically, the leveraged players who participate in the action via futures will see maximum stress as mark-to-market payments and span margin commitments will require deep pockets to just fuel existing long positions with little / no scope for enhancing long positions on price declines. The age old adage that “money makes money” rules the roost here and nothing beats taking delivery of the precious metals in physical format or ETF and e-silver / e-gold. While the exposure levels maybe smaller as compared to futures markets, you manage to skirt emotional pitfalls arising out of funding an existing position when your broker demands fresh funds to keep your positions “alive”. Less is indeed more and small is of course beautiful, at least in the case of the bullion investment game.
Should you buy, and why?
I think you can ignore bullion and depend on equities and / or fixed income investments alone, at your own financial peril. While equity prices are likely to remain under pressure and provide negative absolute returns for some more time, fixed income investments will mean negative real effective returns as your Bank FD interest rates are lower than your food inflation at the street level. Bullion will offer a store of value and also capital appreciation opportunities provided you think of timelines in multiples of 12 months and incremental in similar multiple periods thereafter.
Remember, barring ETF’s where long term capital gain protection is available after 12 months (only Gold ETF’s are on offer in India), all other modes of investment (physical bars, coins, e-silver etc) are required to be held for 36 months before gains are protected from taxes. If you attempt to speculate in bullion so you can throw a grand New Year party, chances are you may erode your capital base.
The “why” of investing in bullion is all too apparent to a seasoned investor - fiat currencies are likely to lose purchasing power in the coming few quarters / years.
Asian countries may prove to be a power house of economic revival in the coming years, but their population is rising much faster than their resources supply side economics. That spells high inflation - a highly conducive scenario for bullion investors willing to dig their heels in these assets, with a long term outlook.
The Tao of bullion investing
Deploying all your money in one go is a loser’s game. Battle hardened investors seldom empty their bank balance in a single cheque. Periodic investments, especially at prices lower / equal to your last purchase is the way to go. Typically, buying progressively slightly larger quantities when the prices are on the way down south makes sense. That way, your average acquisition costs are relatively closer to the current ruling market prices, reducing your anxiety levels. Since currencies are likely to play a dominant part in domestic bullion prices, you need to monitor interest rates and fix markets to time your bullion buys.
As a contrarian player, I would buy gold / silver whenever banks raise interest rates and drive bullion prices lower in the short term, knowing that the prices would rally all over again, whenever economic pressure points re-emerge at a later date. Over the next 36 months, this strategy should navigate you towards above normal profits. Start nibbling at silver at sub Rs50,000 levels and gold below Rs25,500 levels. Remember, systematic investing at lower values (averaging) will be required, so plan your finances accordingly. Do not get rattled to see a 15 - 20 % dip in prices, especially if some highly leveraged hedge fund in the western markets decides to unwind positions due to financial/ regulatory constraints. History provides ample evidence that such events have occurred with unfailing regularity. LTCM, Amaranth Advisors, Bear Sterns are some examples. These are times when bullion baiters (and haters) have screamed “I told you so”, but bullion has prevailed, and will continue to prevail.
The Ten Commandments of Gold & Silver Buying
( If you only read one thing, then make it this page . )
Ten Commandments For Buying Gold & Silver :
I. Always take delivery
II. Never buy premium if you can avoid it.
III. Buy bullion for business, numismatics for fun.
IV. Buy silver first, then gold.
V. Buy small gold first, then large.
VI. Never buy exotic coins or modern rarities or anything you don't understand.
VII. Know your dealer.
VIII. What governments can't find, they can't steal.
IX. Never swap bullion coins for U.S. $20 gold pieces.
X. Never break the law.
Four Bullion Portfolios & FAQ
Please note that our recommendations vary depending on your concerns and the market.
If you want to invest in gold and silver to protect your assets and have something easily divisible and spendable in the event to hedge currency depreciation or collapse, then:
v If you have $5,000 or less to spend
At least half in silver – either US 90% silver coin or 1oz. Silver Rounds
half in British Sovereigns, French 20 Francs, or 1/4 oz. American Eagles. (All references to “ounces” below mean troy ounces of 480 grains or 31.1034 grams).
v For $10,000 buy
two-thirds US 90% silver coin or 1oz. Silver Rounds
the balance divided between a fractional coin like British Sovereigns, French 20 Francs, or 1/4 oz. American Eagles AND Krugerrands, Austrian 100 Coronaes or Mexican 50 Pesos..
v For $25,000 buy
two-thirds US 90% silver coin or 1oz. Silver Rounds
half of the remaining third in Sovereigns, French 20 Francs, or 1/4 oz. American Eagles, and the balance in one oz. Krugerrands, Austrian 100 Coronas, Mexican 50 Pesos, or American Eagles.
v For $75,000 buy
two-thirds US 90% silver coin or 1oz. Silver Rounds
$5,000 worth of Sovereigns, 20 Francs, or 1/4 Eagles
the balance in Krugerrands, American Eagles or 100 Coronas. For over $75,000 simply do multiples of this portfolio.
If you want to invest in precious metals to simply protect your assets and don’t think you’ll ever need to actually barter with them, then
v If you have $5,000 or less to spend
half in US 90% silver coin or 1oz. Silver Rounds
half in one ounce Krugerrands or American Eagles, or in Austrian 100 Coronas or Mexican 50 Pesos.
v For $5,000 through $25,000
Put at least half of your money in US 90% silver coin or 1oz. Silver Rounds
Put the rest in one ounce Krugerrands or American Eagles, or in Austrian 100 Coronas or Mexican 50 Pesos.
v For $75,000
Get bags of US 90% silver or 1oz. Silver Rounds for 2/3 of your order
The balance in Krugerrands, American Eagles, 100 Coronas, or 50 Pesos. For over $75,000 simply do multiples of this portfolio.
Moneychanger, what is US 90% silver coin and why do you recommend it?
US 90% silver coin is quarters, dimes, and half dollars minted before 1965. Each face value dollar (4 quarters, 10 dimes, or 2 half dollars) contains 0.715 of an ounce of silver. Coins are traded in “bags” of $1,000.00 face value containing 715 troy ounces pure silver. (We refer to a “face value dollar,” the value stamped on the coin’s face, which is always less than from the “paper dollar” cost you must pay. So if you have $1,000.00 in paper dollars to spend, you will never get $1,000.00 face value.) You can purchase any portion of a bag that you wish.
We recommend 90% silver coin simply because it is often the cheapest, most divisible, most widely recognised and traded form of silver.
What about Silver Rounds, what are those?
Silver Rounds are simply one ounce, 99.9% pure silver coins minted in the United States. They are made by various private refineries and are NOT just round “blanks” of silver. They all have varying pictures because these companies have varying production runs using different designs. Regardless of the picture on their front and back, all silver rounds we sell state clearly on their face, “1oz. Silver, 99.9% pure (or .999 fine).”
We sometimes recommend Silver Rounds instead of 90% Silver Coin because premiums (not our commission - the premium is the percentage over the spot price that you pay for a coin) on both coins fluctate for a variety of reasons. Since we consider it our duty to sell you liquid coins for the best price, sometimes our recommendations change.
Moneychanger, why do you recommend gold coins like Krugerrands, Austrian 100 Coronaes, and Mexican 50 Pesos, and what are they?
We recommend these foreign coins because they cost less per ounce and give you more gold for your money than the American Eagle gold coin series. All of these coins are well known in the industry and any dealer will readily buy them.
The 22 karat South African Krugerrand gold coin contains exactly one troy ounce of fine (pure) gold. The American Eagle copied the Krugerrand’s specifications, and is minted to exactly the same weight and fineness.
The Austrian 100 Coronae is an official re-strike from the Austrian mint. It is 20 karat (90% pure) and contains exactly 0.9802 troy ounce fine gold.
The Mexican 50 Peso is an official re-strike from the 400-year old Mexico City mint. A 20 karat coin, it contains exactly 1.2057 troy ounce of fine gold.
These three coins take turns as the cheapest on our price sheet.
What about the purity of the Krugerrand, Eagle, 50 Peso, and Austrian 100 Coronae? Will they be worth less later since they’re not 24 karat?
Purity is largely irrelevant among gold and silver dealers. Coins and bars are bought and sold based on their weight, not their purity. Unless you’re going to melt the coins down, it’s just not an issue.
Why do you recommend older-issue, foreign fractional gold coins instead of modern issues or American Eagle fractionals?
Modern issues like American Eagles, Maple Leaves, Philharmonics, and Nuggets include half, quarter, and tenth ounce coins: the smaller the coin, the higher the cost per ounce. With the smallest coins, premiums over the gold content approach 15%. That makes no economic sense because gold is gold. British sovereigns (containing 0.2354 troy ounce fine gold), French 20 francs (0.1867 oz.), Swiss 20 francs (0.1867 oz.), German 20 marks (0.2304 oz.), Netherlands 10 guilders (0.1947 oz.), the whole series of Mexican peso coins, and a number of other gold coins offer lower cost per ounce and good liquidity. Not recommended are gold coins so infrequently seen in this country that you will suffer a big discount when you sell them, such as Iranian Pahlavis (0.2354 oz.) or Saudi guineas (0.2354 oz.). If you can’t sell them, they’re not a bargain.
Moneychanger, nowhere in your recommendations do I see anything about pure gold coins like the Canadian Maple Leaf or Austrian Philharmonic. Why not?
Gold is one of the softest and most ductile metals. Pure gold coins scratch and scar very easily unless handled with extreme care. Throughout history gold coins have generally been alloyed with copper or silver, hardening them to withstand circulation. Customers often unwittingly damage pure gold coins and therefore receive up to 5% less for them when they sell. In our opinion the purity of 24 karat gold confers no benefit and in fact often creates drawbacks.
What about government gold confiscation, Moneychanger?
We expect it more likely for you to be abducted by aliens than for the Federal Government to attempt gold confiscation.
First, gold no longer forms a significant part of the monetary reserves in this country, as it did in 1934 and therefore, confiscation makes no sense.
Second, the folks who tell you about government confiscation are generally trying to sell you overpriced coins that will line their pockets and empty yours.
For more on this topic, go back to our homepage and click on Numismatics/Confiscation among the bulleted items.
Franklin Sanders 

Also See:
Buy Gold and Silver! (Part 1)
08 April 2009
Buy Gold and Silver (Part 2)
13 November 2010