Gold & Silver... How Do I Own Thee?
... Let Me Count The Ways
March 2009Last 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
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.
4. 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.
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.
(Part 2 will be posted shortly)
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