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Gold and Silver... How Do I Own Thee?... Let Me Count The Ways

Last year I published an article that outlined a few nasty things that were likely in store for the economy. The impetus of the essay was a major event that occurred that March, namely the failure of investment banking firm Bear Stearns. That was a shot heard round the financial world. My article noted that there were a lot banks out there in the same bowl of stew as Bear Stearns, and that the next round of failures would be banks with names that everyday folks would recognize. In short, the message of the essay boiled down to something along the lines of ...."Hey we've got an iceberg coming up, and although the people steering the boat (the Federal Reserve, et al.) see it coming, not only are they not going to tell us about it, they are so drunk (with power) they aren't capable of steering around it. So, we'd better start building a life raft." The article concluded that the best way to protect oneself from this irresponsible behavior was to transfer assets out of the stock market and into gold and silver.

This article, which is an endeavor to sum up all the myriad number of ways one can invest in precious metals, was sponsored by another bought of "March Madness". On March 18th of this year the Federal Reserve did something that was at the same time both unthinkable, yet inevitable. The "Fed' committed to directly purchasing long term securities issued by the US Treasury. The implications of this announcement cannot be understated. Treasury securities (T-bills, T-notes, T-bonds) are the key instruments used to finance America's deficit spending. Traditionally, deficits have been financed domestically by borrowing from US citizens and businesses. But as US savings have declined over the years and dollars have flowed overseas due to trade imbalances, the deficit is now financed in great part by foreigners... particularly China. This source of funding - the last available - may be coming to an end however, as the worldwide economic contraction has slowed the inflow of money to foreign countries. One reason, China is running low on excess funds from trade surpluses to purchase new treasury debt. Why? Consumers are buying less of the stuff China makes. Less consumer spending begets further slowdowns and more unemployment... which in turn begets less money heading to China. It's a downward spiral.

The vast sums of new financing required to feed an ever growing US deficit was already a huge problem. We were already robbing Peter to pay Paul. But now it's much worse. Now we're robbing Paul to pay Paul. In order for the Federal Reserve to purchase the staggering amount of treasury debt required to offset the coming shortfall of foreign investment, it will need to 'monetize the debt'. This is also known as 'Quantitative Easing', or in less cloaked terms, 'The Nuclear Option'. In plain English it's called 'Printing Money Out of Thin Air'. That's what officially started this March. The inevitable result of such a policy is monetary inflation on an unprecedented scale. The inevitable result of monetary inflation (an increase in the supply of money) is price inflation (an increase in the cost of goods and services). If you dilute something - a cocktail, a senate bill, or a currency - it loses potency. It takes more and more of that thing to accomplish the same task. In short, prices go up. Dramatically. On top of putting our decedents on the hook for the massive debts being incurred (robbing Peter), we are taking from ourselves in the here and now by dramatically diluting our purchasing power (robbing Paul) to continue this spending spree. What's we are actually witnessing is the largest transfer of wealth in history. For now though price inflation is in check because all these new dollars are not yet circulating through the economy. Banks are reluctant to start lending again. Number one, they don't know if they will be paid back... and number two, it's difficult to know the value of the asset you are lending money on when the asset's value is still falling. Asset values are dropping in part because of the credit crunch. Another downward spiral.

Ah, yes. Asset values are falling. The price of many things is going down, not up. Inflation and deflation are in a wrestling match. How will this contest be decided? What is going to rise in value and what will drop further? What affect will the deflation now taking place have on the price of gold and silver? So many questions....so few answers.

What do we know?

There is perhaps no greater debate taking place in economic circles today then the inflation vs. deflation debate. There are strong opinions - as well as evidence - on both sides of this question. We can't take the issue completely apart here, but what if we ask ourselves a basic question: What do we know? To as great a degree as possible, what do we really know about what the future will bring? I believe we really know a very few things... but one is that America will continue to try and spend its way out of this economic crisis. We can be quite certain of this. The folks controlling the levers of power; The Executive Branch, The Department of the Treasury, The Federal Reserve, the Congress... have all spoken with an unwavering message during both the current and past administrations. The record clearly indicates that whatever amount of money needs to be spent will be spent in order to stave off economic crisis. The fact that we don't have the money is irrelevant. Deficit spending will not be halted. We also know that the financing mechanism of deficit spending is now breaking down. And, we now know how that will be responded to; the Federal Reserve will step in to buy any Treasuries that the market place cannot absorb. Plus we know that these events are going to trigger more fear, uncertainty, and doubt (FUD). The marketplace understands how destabilizing the Fed's move is, and further chaos is sure to ensue. At some point the system of financing US debt is going to break. Want proof? The insurance to protect against the default of US Treasury debt has gone up 15,000% in the last two years (not a typo).

Beyond that we may not know much more for certain. We don't know for sure which way the heard will turn when it stampedes. We don't know for sure what additional shenanigans the folks in the pilot house may pull. But just underneath what we are certain of, there are perhaps some reasonable inferences that can be made. Monetary history tells us that inflation ultimately trumps deflation (if the money gets in to circulation). If you water down a currency long enough it will eventually become near worthless, and things priced in that currency will reflect that. There's no telling exactly when that will occur though, as the unwinding process of overpriced assets has the momentum for the time being. But from the perspective of owning gold it may not matter. The marketplace may well react to perceived inflation long before prices actually rise. Large amounts of money - fearing future price inflation - may exit the long term bond market looking for a safe refuge... with few places of refuge still standing. And, uncertainty itself can at any time trigger a flight to safety. Conclusion... it's not only still a reasonable thing to buy gold and silver, it's more prudent than ever. Supplies of precious metals are tightening, so it's best to buy while you still can. Just remember that in the short term anything can happen. We could easily see a dramatic rally in the stock market. Not a new bull market mind you, but rather a continuance of the relief or bear market rally that commenced in mid-March. Gold and silver could easily decline in price - perhaps significantly - if money moves out of safe havens (gold) and ex-safe havens (the bond market), and back into stocks. Ultimately gold will price itself in relation to the inflated currency (in the thousands of dollars). Also be aware that our monetary system, which is in a precarious condition, could disintegrate before eyes in a flash, with credit lending completely locking up, the bond market utterly collapsing, the US dollar collapsing, and foreign trade and imports coming to a grinding halt. It's difficult to predict whether these events, if/when they occur, will take weeks, months, or even a few years to transpire. At the end of the day however... gold is money, and will act as a store of wealth throughout the turmoil.

To repeat, supplies of physical gold and silver bullion are tight. Much tighter than last year. This may stay true even if the price drops, as dealers are starting to hoard. This essay hopes to enlighten you as to the best way to invest the dollars you choose to allocate to your gold and silver safe haven. The vast differences in the array of gold/silver investment vehicles are daunting, and if you're not careful you could end up without the umbrella of protection you may be expecting from your investment.

So with that rant out of the way, whether you are a precious metals fence sitter just having a look, or have already drunk the gold-is-a-good-thing Kool-Aid, lets' get started.

What's Out There?

There are many ways to buy gold and silver. Each instrument for tying your fortunes to those of the precious metals has its pros and cons. The teeter-totter being ridden here is occupied with pure safety and a somewhat throttled chance of large gains on one end . . . with high risk and staggering returns on the other end. The mix in between runs the gamut, providing a path to gold/silver investing suitable to everyone's risk profile. We will start on the safe end, and meander to the riskier part of town from there.

First Question: Gold or Silver?

A good first question is; should one own gold or silver? The short answer is; buy both. There are some very real differences between these two metals beyond their color and price per ounce. Holding both gold and silver adds diversity to your portfolio. But let's briefly look at some the differences so that you can make up your own mind.


Gold is now and always has been thought of as money. There's less of it mined than silver, and after all scarcity is what gives such metals their precious moniker in the first place. Gold is all shiny and, well . . . golden. It attracts the eye. For these and a number of other reasons, gold has always been the king of real-mediums-of-exchange, and that is reflected in its price, which historically has sold for roughly 15 times the price of silver.


Silver is no slouch however. Although in times of stability silver is more of an industrial metal than a monetary metal, when a nations' currency is in crisis silver also behaves like a monetary metal and tends to rise with the tide of gold. Here are four reasons why it's smart to have some silver in your precious metals portfolio:

  1. Due to its lower price, silver may be easier to purchase for some budgets.

  2. For those buying gold/silver coins for emergency use as money, silver is easier to use as tender for smaller purchases. It's easier to buy a loaf of bread with a 1oz silver round or a pre-1965 quarter than a 1oz. Gold Eagle.

  3. Gold and silver do not necessarily rise uniformly in price. Although not assured, there is reason to believe that silver will ultimately appreciate in value more than gold, since the ratio of gold to silver is currently much higher than its historical precedence. Although both gold and silver have greatly appreciated in the past few years, silver has not kept pace with gold.

In more recent history the average gold/silver ratio has been closer to 50:1

  1. Some think the gold/silver ratio will normalize, and that it will likely be due to a significant rise in the price of silver, as opposed to a big drop in the price of gold. Another way to put it is that the price of silver could double from here much sooner than gold. However, this is not a done deal. As the world economies fall into depression there will likely be less demand for the industrial uses of silver. It could easily turn out that only a total collapse of the currency could cause the gold/silver ratio to come back to historical alignment, in which case silver would be sought after as a highly effective means of exchange.

  2. Conversely, once silver is used for industrial purposes it's hard to reclaim from the electronic circuits it is used in. Gold on the other hand is easier to reclaim, as the jewelry it's often fashioned into can be melted down. Some believe that as investors accumulate more and more silver it will leave less for industrial use and cause silver's price to rise, even in a down economy.

Investing in Gold & Silver


Captain Hook had it easy. His precious metals investments consisted mostly of 'pieces of eight' and other coins he acquired from his conquests. You too can acquire coins, and it's a darn good time to be doing just that, as supplies are getting tight. In fact there is a strong argument for putting the bulk of your precious metals portfolio into gold/silver coins. Direct ownership of gold/silver - having physical coins in your safe or buried in the back yard - protect you from more kinds of economic, social, and governmental maladies than any other form of ownership. The adage, a bird in the hand is worth two in the bush, goes double when it comes to precious metals.

Note: For you trivia buffs, a piece of eight was a Spanish coin containing a little under1oz of fine silver. The unit of measurement was 8 'reales' (royals), later known as a peso. The coins were often cut into 'pieces' to make change.

Having noted that, there are a number of other ways touted to invest in gold... which can be confusing... thus this article. In general, the purchase of gold can be divided into two general categories; Physical Gold ... and Paper Gold (this labeling of course applies to silver as well). Physical Gold refers to precious metals you can see and touch. You not only own the gold/silver, you can put your hot little hands on it as you please. Paper Gold, on the other hand, is any other form of precious metals ownership or investment. The risk of owning Paper Gold varies according to the instrument itself, and will be defined further as we go along.

Physical Gold

Gold and silver in physical form is available as bullion; either as bullion coins or bullion bars. Bullion coins are the more popular of the two forms. Coins sell for a slight premium over bars, with the premium varying according to the coin.

Low Premium Coins

Category: Safety/Maintenance of Wealth
Low premium coins are probably the safest way to own gold/silver. Such coins are an excellent vehicle both for protecting your wealth, and possibly increasing it as well. Any premium attached to such coins is normally recaptured at time of sale, minus a commission. In the event of an emergency, low premium gold/silver coins would be an excellent form of money to purchase goods.

Note: It should be noted that the phrase "low premium" is relative. The premium on gold/silver coins jumped dramatically late last year commensurate with the drop in the price of spot gold and silver. In other words, dealers were not tempted to part with their inventory at such "low" prices, and the premiums attached to coins therefore rose from an average of 2-3% up to 15% or more.

Here are some examples of low premium coins:

The popular gold American Eagle. Low premium. Instantly recognizeable. Exactly 1oz of gold. Considered legal tender in the US. Also available in 1/2 oz, 1/4 oz, and 1/10 oz weights.

The South African Krugerrand is one of the lowest premium gold coins available. Exactly 1oz of gold. Legal tender in South Africa. Also available in 1/2 oz, 1/4 oz, and 1/10 oz weights.

The silver American Eagle is very popular as well. Exactly 1 oz. of silver. Premiums on this coin have risen out of proportion to other low premium coins however. Caution is therefore advised, as the goal is usually to pay for the lowest premium coin.

The silver "round" pictured to the left is not a legal tender coin. It is a privately produced coin with exactly 1oz. of silver, stamped accordingly. Silver rounds are the lowest premium 1oz. coins available. Shown here is a round from the Sunshine mint. Premiums vary from mint to mint. Rounds are well worth considering for both maintenance of wealth and emergency use.

Traditionally, the absolute lowest premium silver coins have been the so called "junk" silver coins. These are US quarters and dimes minted prior to 1965 and of course are still legal tender in the US. They contain 90% silver. These are great coins for emergency use, as they are the smallest denomination PM coins available. Premiums are rising though, as demand for such coins rises while supply stays static.

A full bag of junk coins ($1,000 face value) costs several thousand dollars. Those with a smaller budget can purchase individual coins through a local dealer or on EBay. Pictured at left is a Mercury Dime. These dimes were issued between 1916 and 1945 and contain 90% silver. Look for low premium, circulated coins that still show the engraving marks. Someday these coins may once again buy a loaf or two of bread.

Note: Although once readily available, many low premium coins are getting harder to find, and the premiums are trending upward. The market changes fast, so be sure to comparison shop when seeking the lowest premium coin.

Numismatic Coins

Category: Speculation
A numismatic or collectable coin has some special attribute that causes the coin to sell for well over the value of the gold or silver it contains. While all gold & silver coins sell for some amount over the price of bullion bars, numismatic coins sell for a significant premium, usually due to the coin's age, scarcity, and/or quality.

As a general rule numismatic coins should be avoided. The premium attached to these coins is substantial, highly variable, and there is no guarantee that such a coin will sell for the same premium it was purchased for. You can lose money investing in such coins even if the price of the underlying metal goes up. In the event of an emergency, where coins would be used to purchase goods and services, it is unlikely a numismatic coin would be worth anything more than the actual amount of gold or silver it contained.

Although this 1914 $20 Saint-Gaudens Double Eagle pictured at left looks similar to the 1999 Gold Eagle shown above, the two coins are substantially different in terms of the premium attached to each. Both coins contain exactly the same amount of gold, and each depicts Lady Liberty on the front of the coin. However the Saint-Gaudens sells for a substantial premium over the contemporary Gold Eagle, and is therefore a higher risk coin to own, as one cannot be guaranteed that buyers will be willing to recognize the numismatic value when the coin is sold. In some circumstances premiums on numismatic coins do of course rise, but you have to be an expert, or be lucky. Most people should stay away from numismatics.

Be advised that the standard argument dealers use to entice customers into purchasing numismatics is that collectable coins were the only form of precious metals that people were allowed to continue to own when gold was confiscated from US citizens in 1933. This is true, and confiscation could happen again. But there is no guarantee that numismatics would be exempt, as we live in very different economic times. And unlike in 1933 we are no longer on the gold standard, which was germane to the confiscation.

Bullion Bars

Category: Safety/Maintenance of Wealth
Gold and silver bars often carry lower premiums than coins; partially because of lower manufacturing costs on conventional bars, and partially due to the ease of recognition of coins. A variety of weights are available, from 100 gram bars to 400oz. bars. Smaller bars often carry premiums close to coins. Always check the premium on all gold/silver bullion products, as it is in constant flux with the constant changes of supply/demand.

This completes our discussion of Physical Gold. It's a pretty quick study, really. You determine the ratio of gold to silver you want, the mix of coins and/or bars you wish to buy, and you phone a reliable dealer for a quote (see links at end of article). You take receipt of your bullion, hide it somewhere safe, and keep your mouth shut. Seriously. If you ever discuss owning gold with another human being besides your spouse, make a reference to any holdings you admit to as being held in storage by a trusted third party. Better yet... just keep quiet. Now you are about as safe as you can get. From here we will work our way up the risk ladder and look at other forms of gold/silver ownership and investment opportunities.

One alternative to storing your precious metals yourself is to make use of a paid storage facility. Most third Party storage is actually a form of Paper Gold, and is discussed below. The only form of third party storage within the realm of Physical Gold is a facility that you can physically walk in to, open a locked box that only you have the key to, and retrieve your precious metals holdings (and even here we are stretching the definition).

The most well known form of such a facility is a safe deposit box in a bank. Believe it or not though, safe deposit boxes at the local bank may not be as safe as they used to be. A number of articles have appeared reporting that money starved states have confiscated the contents of active safe deposit boxes for no other reason than they had not been accessed for a while (in one case only six months, and the person had an active checking account). ABC News reported a class action lawsuit against the state of California for this activity. Additionally, safe deposit boxes are not insured by the FDIC, and are vulnerable to theft, flood, and fire.

Paper Gold

There is sometimes good reason to augment your stash of physical gold/silver with Paper Gold. Paper Gold is any precious metals ownership that entails the issuance of a receipt, certificate, brokerage statement, online statement, or a rock with writing on it. If you are ever in doubt as to whether you own Physical Gold or Paper Gold, just look down at your hand. Is there something shiny there or a just piece of paper? If it's not bullion, you own Paper Gold. Anything with writing on it is simply a claim check. The claim can vary from a promise of bullion stored in some remote location, to a mining share certificate. Some forms of Paper gold may be worth investing in...other forms should be avoided. Just remember that Paper gold is never a substitute for Physical Gold.

Third Party Storage

The first step up the risk ladder of Paper Gold is entrusting a stranger to hold your physical gold for you. There are vaults in various locations around the world that specialize in storing precious metals, most notably in Zurich, London, and New York. Although some may consider this form of bullion storage still in the realm of Physical Gold - after all it is supposedly physical gold stored in the vault - we are going to classify such storage as Paper Gold, because... again... look down at your hand. Storage of bullion through third parties though can be a great way though to diversify your holdings... or not.... depending on how you set up the account.

The third party storage of precious metals takes on two distinct forms, generally referred to as unallocated and allocated. There is a massive difference between the two types. Unallocated storage involves what's called a pool account, whereby your holdings are commingled with the holdings of others. An unallocated account gives no title to any specific bullion. Your purchase receipt is in essence a "promise to pay". You are actually just a creditor of the holding institution. If the dealer goes bankrupt you are simply a general creditor and stand in line with all the other general creditors in hopes of what will likely be a cash settlement, at best. Another weaknesses of unallocated bullion accounts is that there is no real guarantee that the dealer actually has the same amount of gold in storage that it has issued receipts for. Think about that. Just as the US banking system is fractionalized - there are always more deposits then there is cash on hand at the banks to satisfy those deposits - there is a temptation for the bullion dealer to do likewise. The dealer, certain that not all of its customers will demand delivery of their gold at once, is tempted to lend some of the bullion out, greatly leveraging its holdings, and thus its revenue stream. Sounds like a good deal for the dealer, huh? What's more, there is a growing fear that unallocated bullion has become more leveraged then ever, with each bar of gold and silver in storage having a significant number of claims against it. Sounds like musical chairs to me.

An allocated account is very different. In an allocated account the bullion must exist, and the amount you purchase is stored in your name. You hold actual title to your precious metals. The dealer in this case is guaranteeing that it has the same amount of assets in bullion as there are claims against those assets. If the dealer has 100 customers each holding title to 100oz. of gold bullion, the dealer is guaranteeing to have 10,000oz. of gold bullion in the vault at all times... and free of encumbrance by any other party.

So, an allocated account sounds a lot safer than an unallocated account, right? Right. But it still comes down to the fact that you have to trust that the dealer is honest, right? Right. So how do you know who to believe? Who has the most trustworthy pieces of paper? Fortunately, with an allocated account you don't have to worry quite as much about the bank or dealer who sold you the bullion. The dealer is more of a middle man, as the holding facility itself records your name as having title to the amount of bullion you have purchased. Although you haven't taken physical delivery of your bullion you have taken legal delivery (legally known as bailment). If the dealer - or even the holding facility - goes bankrupt, you still have legal title to the bullion in storage and therefore do not need to stand in line with creditors. In essence you are eliminating what is known as "counterparty risk"; the risk that a party to a contract is unable to live up to its contractual obligations due to say, bankruptcy. Now having said all that, you of course still need to trust that the dealer and storage facility will do what they say they say they are going to do, right? The dealer must be trusted to place the gold in the vault. This is known as "performance risk". So, the customer must still discern who to do business with, even in the case of allocated accounts (see below).

Third Party Storage - Store Your Bullion in a 'Bank'

Category: Safety/Maintenance of Wealth/Flexibility
Here is the first of three common ways you can employ a third party to store your gold. Store your gold in a 'bank'. No, not a safe deposit box in a conventional bank. We covered that option earlier. I'm referring instead to a newer class of institutions that have established the concept of Digital Gold Money or Digital Gold Currency. This particular category of third party storage is characterized by how readily you can buy and sell gold, as well as the ease of converting that gold/silver to currency.

Think of these digital gold institutions as kind of an online bank, except that your holdings are stored not as currency, but rather as bullion. The account balance is unaffected by the fortunes of a particular currency, and instead rises and falls in value with the price of gold. What's more, your bullion can be stored in overseas vaults, and you can access your account from anywhere in the world. And if you like you can convert your bullion into a variety of currencies at any time. It's a very flexible system and a pretty cool idea. Here are two popular digital gold banks: BullionVault.com and GoldMoney.com.

If you choose to investigate such a vehicle for storage of your bullion you of course know the Big Question to ask about the account, right? Allocated or unallocated? Only allocated accounts are offered by the aforementioned institutions. But even with an allocated account there is still that nagging question of validating your holdings. How do you know your gold is really there? I am going to use GoldMoney.com here as an example to hopefully shed some light on this question. As it happens, GoldMoney has put a lot of effort into substantiating its holdings, and in doing so has created a benchmark of sorts for the industry. GoldMoney employs a five part process to insure the purity, weight, physical safety, verification of holdings, and verification of ownership of the customer's bullion.

  1. GoldMoney is regulated by the Jersey Financial Services Commission, Jersey, British Channel Islands. This in part means that GoldMoney is careful to identify its customers to avoid being used for money laundering. This in turn helps keep the institution sound.

  2. All bullion meets the London Good Delivery Standard established by the London Bullion Market Association. This insures weight and purity of your holdings.

  3. GoldMoney employs the Swiss company VIA MAT to store its holdings. VIA MAT also meets the London Bullion Market Association standards. This insures physical safety of your holdings.

  4. Holdings are insured by Lloyds of London. This insures against losses by the vault.

  5. Most importantly, the holdings of GoldMoney are periodically verified by one of the "Big 4" auditing firms. This insures sufficient bullion exists to match the claims in GoldMoney's customer database.

The fifth element in the system is critical to insuring that no one else has claim to your pile of gold. Not all allocated accounts have this independent assurance. Additionally, GoldMoney has pioneered a gold based payment system that allows electronic payments of grams of gold to private parties. What I find particularly interesting is that you can actually take delivery of your gold (this of course incurs additional expenses). By the way, GoldMoney is also qualified for IRA accounts. An IRA is a good reason for using Paper Gold, as gold coins buried in the backyard certainly don't qualify for an IRA.

BullionVault is another digital gold bank that provides allocated, audited accounts. There are differences between BullionVault and GoldMoney in terms of the way the companies are structured, the validation and audit procedures, as well as services provided. A full comparison is beyond the scope of this article, but in brief GoldMoney operates under a higher degree of regulation, a more strenuous audit procedure, allows for purchases of silver as well as gold, and employs a payment system for sending "goldgrams©" to others. GoldMoney also has the flexibility of wiring funds from your GoldMoney account to any bank of your choice. BullionVault has less regulation and audit procedures, and has fewer bells and whistles than GoldMoney, but it too is structured to insulate its customers from counterparty risk. In addition, BullionVault only allows you to wire funds to the same linked account you funded your BullionVault account with (the linked account can be changed but it's an elaborate and time consuming process). This can be construed as an additional safety measure in the event your digital gold account was to be hacked.

BullionVault also has a "burglar alarm" feature that sends a message to your cell phone when your account is accessed.

Finally, costs vary from one digital gold bank to another. A commission is charged at the time of purchase and sale of bullion, storage fees are incurred, as well as fees for other types of services.

Third Party Storage - Store Your Bullion With Your Precious Metals Dealer

Category: Safety/Maintenance of Wealth
In this next flavor of third party storage, we have precious metals dealers that not only buy and sell bullion for delivery, they will also store your holdings for you in a vault. These companies differ from digital gold money institutions in that they are primarily bullion dealers who also happen to offer storage, but don't offer the additional services of the digital gold banks. Some examples are: kitko.com, monex.com, and fsdepository.com.

Naturally you will want to ask any bullion dealer you store your precious metals with the Big Question, understanding that unallocated storage is simply getting more and more risky these days. And even when the answer to the question regarding allocated storage is "Yes", you still want to dig further. Does the facility uses mechanisms similar to those employed by GoldMoney, especially the all important independent verification of ownership. I cannot emphasize this point enough, as my research indicates a vast game of musical chairs may be underway with unverified bullion holdings in storage. The music is going to stop one day and some folks may find a pile of something other than gold bricks in their seat.

Third Party Storage - Store Your Bullion as Gold Certificates

Category: Safety/Maintenance of wealth
Here we have yet a third way to store gold offsite; namely gold certificates. Gold and/or silver certificates have been around for a long time, and are simply another mechanism for being issued a paper receipt for your gold. Historically in the US the issuance of gold certificates took the form of paper money used in every day transactions. Up until 1933, when gold certificates were made illegal, a citizen could literally redeem their certificates for gold coins.

You could trade dollars for gold up until 1933

Today, gold certificates are issued by certain banks, trading firms, or mints, and purport to be redeemable in gold. Examples would be perthmint.com.au and kitko.com. Should we be confused by yet another vehicle for the storage of bullion? How do we discern the validity of the so called gold certificate brand of Paper Gold? Simple. Just ask the Big Question. If the holding account is unallocated you may be taking on more risk than necessary.

Let's use the example of a popular gold certificate program issued from the Perth Mint in Sydney, Australia. The Perth Mint is well known for the many beautiful series of gold coins it produces. It also has a certificate program whereby it will hold bullion on account for you at its secure facility. The program is called the Perth Mint Certificate Program (PMCP), and is wholly owned by the Western Australia Government. In fact, the PMCP is the only government sponsored gold certificate program in the world.

Wow. A certificate program backed by the full faith and credit of a government institution. What does that tell you? Not much. The question with Paper Gold is always the same; unallocated or allocated? In the case of the Perth Mint Certificate Program, both types of accounts are available. The mint's allocated account holdings are insured by Lloyds of London. Also the Australian government backs the holdings and has a Standard & Poor's AAA investment rating. There is even a provision for taking delivery of your holdings. And, the allocated program allows investing in gold, silver, and even platinum. This all sounds very impressive, however there is precious little on the mints' website indicating how rigorously the allocated accounts are audited, particularly the independent verification that the amount of bullion in storage matches the number of certificates issued. It appears that at least some holdings may be audited by a third party, but the mint never responded to a query as to the details. To this author the promise of a government backing a certificate program does not hold as much water as it used to. In addition to the economic stresses being endured by all first world countries, the Western Australian government has a law already on the books that allows for all gold to be confiscated "for the protection of the currency or of the public credit of the Commonwealth". Finally, if you consider purchasing a Perth Mint certificate, be sure to compare storage fees with those other institutions offering allocated accounts.

As noted above, the Perth Mint Certificate Program also offers unallocated bullion storage. The mint asserts the safety of its unallocated accounts by noting that the accounts are insured, 100% backed by the Western Australia government, and insulated from counterparty risk. While this may be true, you should think twice before opening such an account, even though it offers free storage. For one thing, you cannot take delivery of your gold without first converting to an allocated account and paying additional fees. In addition, there is a statement on the certificate stating "The Perth Mint will not be liable or responsible for delivery delays due to causes beyond its control". To be fair, the mint's unallocated program has been in existence for over 100 years, is apparently blemish free, and has many satisfied customers. Still, the program is controversial because the holdings are unallocated. As a point of interest, some major figures in the investment world have lined up either in support or in condemnation of the unallocated program. Although the program may well be sound, this is a time in history to be especially careful about taking unnecessary risks, especially when alternatives exist. Also note the remarks above regarding the Australia Government's power to confiscate gold. This could certainly affect unallocated, as well as allocated accounts.

[Let's make a clear distinction at this juncture. It is very important for you to understand that we are now leaving the realm of direct ownership of gold. The methods covered thus far for purchasing gold/silver are all about either taking physical possession of coins/bars, or taking legal possession and storing the bullion in allocated storage. Those are the only two ways to truly own gold, and the only two ways to maintain your wealth apart from the gyrations and risks of paper currency and counterparty risk (when a party to the arrangement is unable to meet its obligations), which is extreme at present. The price of gold does not really fluctuate much. It's the value of paper currencies that change in relation to gold. This is the core reason to own physical gold. Every other form of gold/silver investments are simply speculations on what will happen to the "price" of gold measured against a particular currency. With that caution, only "investors" need read further.]

Gold/Silver ETFs

Category: Flexibility/Speculation
Moving away from third party storage of your bullion what we have here is a way to invest in gold as you would a stock. An ETF (Exchange Traded Fund), if you don't know, is kind of like a traditional Mutual Fund, only better. Like mutual funds, ETFs allow one to invest in a variety of investment classes (often an index of stocks) much like you would buy and sell shares of stock in a company. Unlike mutual funds, ETFs behave more like stocks in regard to fees and ease of trading, as they can be traded like stocks throughout the day.

Gold and silver ETFs are designed specifically to track the price of gold and silver respectively. These funds are actually backed by their respective metals. In fact, it is through the purchase and sale of the underlying precious metal, that the fund tracks the spot price of that metal. Since the ETF must purchase and store the physical commodity it tracks the price of, as new buyers purchase shares the fund must increase its physical holdings. The most popular of these ETFs, the SPDR Gold Shares Fund, now has holdings of over 1,000 tons of gold... rivaling the stockpiles of some countries.

For those choosing to invest a portion of their portfolios in gold/silver, either as a hedge against inflation, a falling stock market, or for speculative purposes, the gold and silver ETFs are arguably the easiest way to do so. You have an investment vehicle that can be traded through your existing brokerage account, is very liquid, and has a close correlation to the price of the precious metal it tracks. Because of all these features, precious metals ETFs have gained in popularity as the price of gold and silver have risen.

So, sounds pretty good, huh? But if you've been following along, you know what's coming next, don't you? What's the answer to the Big Question? Do the holders of shares in a gold ETF have titled ownership over the physical commodity? Uh... no. But truthfully, no such claim to that effect is made. The purpose of backing the ETF with gold has more to do with giving the ETF credibility - it's not just paper trading they claim - and it's key to stabilizing the price of the ETF to that of the precious metal.

Still, let's slow down here and do a reality check. We have just wandered into one of the fastest growing areas of precious metals investing. The precious metal E-T-F is H-O-T! In the first half of 2009 the amount of gold and silver held in trust by ETFs has grown by leaps and bounds as traditional investors seek a flight to safety through a familiar instrument. Unfortunately gold and silver ETFs have a growing controversy as well. First, let's be clear that a gold/silver ETF is in no way tied to ownership of precious metals. This is a purely speculative investment that simply goes up in price when its underlying metal goes up in price, and vice-a-versa. No one disputes that. One area of controversy though lies in whether or not the amount of gold and silver that is claimed to back these securities does indeed exist. When I researched this debate I found arguments for how well some ETFs manage and audit their holdings, including disclosure of serial numbers of the bars of gold¹. On the other side of the debate though is the assertion that even serialized bullion may have multiple claims of ownership, i.e. the musical chairs theme again. Who knows the real truth, but from what I've been able to glean I will express the following thoughts regarding gold and silver ETFs:

  1. What would happen if even a rumor about ETFs lacking the full backing of their respective metals was taken seriously? The supply/demand mechanics of precious metals ETFs are separate and apart from demand for gold/silver. If these ETF vehicles were fled en mass due to a panic regarding their safety, would the fund managers be able to maintain the equity's price in relation to its metal?

  2. ETFs trade on public, government controlled exchanges. Therefore all the cautions regarding exchange trading in times of economic crisis apply. It's not unheard of for markets to be shutdown and trading halted during times of chaos. And some degree of chaos might be in store at some point, when investors may come to understand that stocks are still highly overpriced related to future earnings. Or that the bond market is underestimating inflation. Or that the world will stop buying our debt. Or that the US dollar will be revalued sharply downward. Take your pick of calamities waiting to happen. Any one of them could cause severe disruption from people exiting these markets. That's why you're buying gold, right?

  3. Gold/silver EFTs are alluring vehicles. They are great for short term trading. They can be used in many cases where direct ownership in gold/silver is not possible (pension funds for example). However, one must understand the counterparty risks with ETFs in today's environment. If a crisis hits, it is possible that these instruments could be one of the early fatalities among the variety of precious metals investment vehicles mentioned in this article.

Here are some examples of popular gold/silver ETFs:

• SPDR Gold Shares ETF (Symbol: NYSE:GLD)
• iShares Comes Gold Trust ETF (Symbol: AMEX:IAU)
• iShares Silver Trust ETF (Symbol: AMEX:SLV)
• PowerShares DB Gold ETF (Symbol: NYSE:DGL)
• PowerShares DB Precious Metals ETF (Symbol: NYSE: DBP)
• DB Gold Short ETN (NYSE: DGZ) this ETN is for shorting gold (betting the price will go down). An ETN is similar too, but riskier than, an ETF. Do your research. There is no equivalent for a silver ETN on an American exchange.

Leveraged Investments in Paper Gold

To review, up until now we have looked at various ways of owning gold and/or silver bullion - both Physical Gold and Paper Gold - as unleveraged investments; i.e. there is 1-to-1 relationship between the dollar amount invested and the amount of gold or silver being controlled. So if you spend $1,000 for a gold coin, you control $1000 worth of gold. If you spend that $1,000 on a gold ETF and the price of gold goes to $1,200, your brokerage statement will reflect a value of $1,200. All the aforementioned vehicles gain or lose value in direct proportion to the price of the underlying metal.

Now we turn our attention to leveraged ways of investing in precious metals. Leveraged investment vehicles, vis-à-vis one mechanism or another, allow you to control more gold/silver than you put up cash for. The result is that your investment gains (or loses) some percentage greater then the price of the underlying metal, depending on how much leverage is applied. Whether through the purchase of an option, buying shares in a mining company, or through other means, the following vehicles provide the opportunity to increase the rate of return compared to an unleveraged investment in bullion.

Leveraged Investments - Bullion on Margin

Category: Speculation
Buying bullion on margin refers to financing a portion of your purchase. The leveraged gained is relative to how much of the purchase is financed. A number of gold/silver investment vehicles can be financed, with margined purchases of bullion being one of the more common. There are dealers who will sell gold and silver bars/coins on margin with as little as 10% down. The customer makes a down payment, so to speak, and the gold remains in the dealers vault as collateral on the loan. The customer then makes payments to the dealer for the portion of the bullion not paid off yet, including interest. The idea is that if the price of gold rises, the profits made on that leveraged bullion will far outweigh the interest payments on the loan.

Danger Will Robinson
Here we have double trouble. The problem with buying bullion on margin is that in the short term, gold and silver tend to go down in price about as often as they go up. When the price goes down, the margin on which you control your bullion is diminished and you may get a margin call, meaning you must make up the difference by increasing your payments. If you can't make the extra payments your holdings may be liquidated.

The second consideration with buying gold/silver on margin is that you have the same issue of unallocated vs. allocated storage covered earlier. The bullion dealer most commonly associated with purchases on margin is Monex.com. Monex promises allocated storage, but a check of their site reveals little regarding any third party auditing of holdings. And just another word of caution; if you call Monex and give them your phone number, they will hound you till the cows come home to make a purchase. To be fair though, Monex has been in business for decades. I have a friend who took delivery of a block of platinum from them and he was completely satisfied with the transaction (he just laughed when they offered him a margin account).

Leveraged Investments - Gold/Silver Mining Stocks

A very popular way to leverage your investment in to the price of gold and silver is by owning shares of gold mines and silver mines. Owning the mining stocks is in no way a substitute for owning gold however. Mining stocks are a pure investment. You can think of the 'miners' as being "part of a complete breakfast" for the portion of your portfolio you wish to allocate toward the fortunes of the price of gold, silver, and certain base meals.

The leverage from owning mining shares derives from a number of factors, but basically in a bull market mining stocks tend to have a greater percent gain relative to the price of the precious metals they mine. When you own shares in a mining company you do not ever own any precious metals; you simply own a piece of a company that extracts precious metals from the ground and sells the commodity at market.

As an investment it is arguable that in the not too distant future mining stocks will be one of the most profitable segments in the class of investments known as equities; i.e. ownership of a company through its publicly traded shares. You just want to remember though that mining companies are affected by far more factors than what pure bullion is exposed to. If something happens that prevents the mine from producing... say the gold runs out, labor costs too high, lack of electricity, lack of financing, or any of a number of other factors... the shares may plummet. Also, if the price of gold/silver falls, the shares of a mining company may fall even further. That's the price of leverage. On the other hand, mining shares are one of the safest leveraged instruments over the long term, as they are less time sensitive then any other leveraged instrument listed in this article. There are no margin calls if the share price drops, and the shares never expire (as options do), with the exception that eventually the mine will reach end-of-life when the ore is exhausted.

In terms of gauging the likelihood that the miners will outperform bullion in the remainder of this current bull market in precious metals, we have some interesting history to go by. If we look back to the beginning of the current bull market that commenced around the time we rolled over to a new century, the miners generally outperformed the metals for much of the bull run. Then last year, when the general stock market dipped, so did the mining stocks. Big time. The miners of course have recovered quite well going into the first quarter of '09, but a good sized chunk of the gains enjoyed by the miners from the start of the bull market have been erased. So, there are two ways to look at the upcoming prospects for the miners. One could say that it is the absolute best time to buy mining shares on the basis that they are a relative bargain and are likely to greatly appreciate as the price of bullion rises further. New money may be attracted to mining shares as traditional stock investors engage in a flight to safety away from traditional equities. Conversely one could say there is great risk that the mining stocks will collapse again if the general stock market declines further, regardless of what happens to the price of gold. That diversity of opinion of course is what makes a market. However, if the price of gold continues to rise as expected, it would seem reasonable to conclude though that over the long haul the price of mining shares will be valued higher than they are now, as the good mining companies will be profitable, and profits (earnings) are what ultimately determine the share price!

Now let's get a bit more specific. Keep in mind that the relative risk of mining stocks is tricky to determine. Below miners are categorized simply by how close the mine is to production, but in fact there are many, many variables. Most folks are better off with a mutual fund comprised mostly of miners or perhaps a mining ETF (both referenced later). Short of that you could subscribe to a good stock picking service such as zealllc.com or growthstockweekly.com. Diversity is key with mining companies!

Producing Mines

Category: Investment/ Speculation, depending on mine
A producing mine is one that is currently retrieving gold and silver from the ground and bringing it to market. Producing mines tend to have the highest stock prices as they are theoretically making money. Producing mines are the safest, but also carry the least leverage.

Near producers

Category: Investment/ Speculation, depending on mine
A near producer is a mine that has proven resources and has spent money on infrastructure to retrieve the ore. Operations are due to commence in the near future. It is expected that, all else being equal, the share price of near producers will rise as the mine goes into production and starts making money. Leverage on such miners is much higher.

Juniors and Explorers

Category: Speculation/wildly speculative, depending on mine
Junior mining stocks represent companies that may be several years away from production. These are often, but not necessarily, properties that have proven resources. Since juniors often lack a built out infrastructure and are some time away from production, the price of their stock is usually well below that of the producers and near producers. The explorers are often "shell" companies sniffing around to prove resources they suspect are there. These stocks have the greatest growth potential and may provide returns of many multiples for those patient enough to hold on until the mine come online. A junior also has just a good a chance of fading into eternity after its stock price goes to zero.

Purchasing Mining Stocks

Mining stocks are traded on various stock exchanges around the world. Shares are purchased through a stock broker, so your current broker may be able to help. Keep in mind however that not all brokerages are able to purchase mining stocks through all the exchanges. For example many mining shares are traded in Canada, such as on the Toronto Stock Exchange (TSX), and not all brokers are registered with the TSX.

Remember that this article is just a primer on investing in gold/silver, and that if mining stocks interest you there is more to learn. One thing further research will reveal is that the country the mine is located in is of paramount importance. It is not unheard of for a foreign government to nationalize a mining company, thus nullifying any foreign ownership of the stock. For that and other reasons, Canada, and to a lesser extent Mexico, are popular foreign countries for investing in the miners.

Reducing the Risk of Mining Stocks

Reducing the risks of owning mining stocks mainly has to do with diversification, a.k.a. spreading your risk across many companies, in various stages of development, with assets in more than one precious metal (and possibly base metal as well).

Up until recently it was possible to actually take delivery on the shares of a mining company that you have a stake in. Normally stock certificates are kept in the name of the broker the shares were purchased through. This makes it easy to trade the shares, but the downside is that if the broker goes belly up, your shares may be inaccessible for an indefinite period of time. Transferring title to your own name, and/or taking physical delivery of the actual stock certificates makes one immune to the fortunes of their broker. However, the rules governing the transfer of stock shares have been quietly altered to greatly restrict this practice. If possible, always take delivery of the shares of a mining company you are holding for the medium to long term. Short of taking possession of the actual physical certificates, is instructing your broker to at least transfer the title of the shares into your name. Check with your broker for details.

¹ A review of the prospectus for the most popular gold ETF traded on American exchanges, symbol GLD, reveals that at least a portion of the holdings are in unallocated accounts, where one would expect that no serial numbers would be recorded. This and other disclosures in the prospectus seem to allow the ETF a rather lax standard with regard to proof of holdings.

Continue to Part II -- Mining ETFs and Mutual Funds ...


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