Investing in Gold and Silver

Investing in Gold and Silver

March 2, 2008


I am going to finish our discussion about How Banks Work, but I’m ready for a little break. Thus, in celebration of new all-time highs in gold (celebration for investors, it’s a big problem for everyone else), here’s a little primer on how to invest in gold.

By the way, the Director of Research of CalPERS, the California Public Employees Retirement System, one of the biggest ($240 billion apparently) institutional investors in the world, has just published a book.

The title is — this is sweet — BUY GOLD NOW

Also, I just gave an interview with Monocle magazine (UK) about investing in gold. The interest level is rising.

NOTE: This is not investment advice. This is my informal opinion, for educational purposes.

For now, let’s forget about gold mining stocks. We’ll just focus on gold bullion, and silver bullion.

First, before we answer how, we have to answer why. Gold isn’t really an investment. There’s no return on capital. It’s a form of money. It’s primary characteristic is that it is stable in value. Thus, owning gold is like putting a stack of $20 bills in a sock, except that instead of some government’s paper nonsense, we’re owning Universal Money instead.

Considered as a currency, gold has one obvious flaw: there’s no interest income. Actually, there’s no interest income in any other currency either. To earn interest, you have to have some counterparty that pays interest. Then, you have all the issues of lending, including credit risk and all the issues of the chain of ownership between you and your brokerage and a money market fund, etc. Usually this is no big problem, but these are not “usual” times today. Between the ABCP and the auction-rate securities and the various “enhanced” money market funds that have blown up, not to mention regular money market funds that have stumbled, many forms of “cash” are showing rather dramatic divergences from the ideal. Any other currency has all of these credit risk issues, plus of course the risk of devaluation. For this you get paid — well, what do you get paid? About 2% in the US (for T-bills), about 3% in Europe, and about 1% in Japan.

And if this makes you start to think about why you would own anything but gold, in these times, you are starting to get the picture.

OK, now how do you go about owning some gold?

I put a high importance on owning physical gold. This means direct ownership. The most basic way is to buy some coins, and keep them somewhere secure. You can try a safe deposit box. There are different kinds of coins, each with a premium to gold bullion. Kruggerands tend to have the smallest premium. However, US Gold Eagles apparently have some legal advantages in the US, as they can be used as legal tender. After all, they come from the US mint, which also makes all the other coins. In general, you pay about a 3% premium to buy a coin, and sell at market.

Buy from a reputable dealer, one that has been around for decades. I wouldn’t buy coins on eBay, although I’d consider selling some there. I like Jules Karp Coins and Bullion (212) 943-5770 in New York City. On the West coast, try Camino Coin (

Silver is usually traded in 1000oz bars, 100oz bars, and bags of silver coins. I personally like the bags. Old US silver coins were 90% silver. $1 face value of silver coins (for example four quarters or ten dimes) contains about 0.715 oz of silver. The bags are typically $1000 face value, so you’re looking at about 715 oz of silver.The old silver coins are legal tender, and come in convenient teeny sizes. They are also about the same price or cheaper than the bars.

I’m hearing that small investors are having difficulty obtaining even a half-dozen 100oz bars of silver these days. Which tells you about all you need to know, eh? It is not well understood that there is actually quite a bit less silver in the world than gold. All of the tradeable silver in the world might come to about 1 billion ounces, while there are about 4 billion ounces of gold. Thus, if anyone gets the idea of holding silver as an investment — as money, rather than as an industrial commodity — there won’t be much to go around. Historically, silver traded at a 15:1 ratio with gold for literally thousands of years. You can buy about 50oz of silver for the price of 1 oz of gold today. Yes, I do think that silver will go to 15:1 sometime in the next few years, and yes, I think you should then sell it and hold gold instead.

For larger amounts, I would look into some kind of segregated, allocated, direct holding. “Segregated” means not pooled. You don’t own a percent of some legal entity, like a limited partnership, which then owns some gold. Nobody owns it but you. “Allocated” means that there isn’t a big pile of gold somewhere, but the part that you own is not distiguished from other parts. You want to be able to say: “This is my bar. There are many like it, but this one is mine.” In practice, this means you get the serial number and specific weights from the bar. (This is advice for holdings of $1m or more.) You might even visit it once a year or so, and make sure the bar in the vault with your name on it matches the serial number.

I would STAY AWAY from pooled accounts like those offered by Kitco or the Perth Mint.

Some big full-service brokerages, like Morgan Stanley for example, offer custody services for bullion investing. Morgan Stanley will buy the bullion for you, and put it in insured storage. There is a small charge for this, typically about 30-50 bps per year.

The problem is, the big brokerages lie. Morgan Stanley just got busted in a class-action lawsuit in which 22,000 investors had ordered Morgan Stanley to buy and warehouse precious metals for them. Morgan Stanley even charged them a custody fee. But Morgan Stanley never actually bought the metal.

You see, the big banks are terrified of people owning bullion. And what does that make you want to do? It makes me want to own bullion.

You might have better luck with HSBC, which offers custody services. Make sure you get the serial numbers and specific weights, and visit your bullion sometimes. Do not ask your coin and bullion dealer (ie a coin store) to custody the metal.

I hear there is also a custody service within the Zurich airport. I would also look into Singapore.

People have mixed opinions of safe deposit boxes. In 1933, the Federal government ordered all safe deposit boxes opened in the presence of a Federal marshal, and gold bullion was seized. It was illegal to own gold in the US from 1933 to 1974. There are some stories of FBI types quietly going though safe deposit boxes today and making gold coins disappear. (Terrorists, you know.) I have heard that banks specifically state in their safe deposit box agreements that you are not allowed to hold precious metals in them. With that said, it seems that people are reasonably content to use safe deposit boxes for quantities too large to store somewhere but too small for insured custody storage. (Let’s say $100K-$500K worth.) Maybe a couple safe deposit boxes, at different banks.

Given the difficulties of owning bullion, two companies have emerged to offer direct held, allocated, segregated bullion custoday and trading with Internet convenience. One is Bullionvault ( This has a convenient, low cost trading system which allows purchases in very small increments (one gram for example). I have used Bullionvault in the past. However, at this point I am more inclined to use goldmoney ( which charges more for purchases (as they must) but doesn’t have the odd “fractional bar” system. Both of these are run by “outsiders” from the traditional banking cartel.

One big advantage of gold’s inconvenience is that it tends to make people sit tight. There’s something about a gold bull that makes it tough to ride. For most holdings, it is probably best to simply buy your position, and sit and wait until the bull finally reaches its last stages. There will eventually be a time to trade your gold for something else, like bonds, equities, property or whatever. Real investments that produce a return on capital, not just the return of capital. That time will probably be pretty obvious, but it will be difficult to act when it comes.

There are a number of trading vehicles that are effectively derivatives of gold. They aren’t really gold itself, but provide a return that is linked to bullion. One of these is the various ETFs popping up. GLD is the biggest. These ETFs are offerings of the Big Banks. One of their purposes is to prevent the purchase of actual bullion. Do you really think that a bank that is going to lie about a direct, allocated, segregated, custody holding — as Morgan Stanley did — is going to play fair regarding the holdings of ETFs? I doubt it. Already, there have been suspicions — based on repeated serial numbers for example — that there really isn’t as much gold there as is promised. Or, maybe there is, but it could be used in the future for some nefarious purpose. The GLD ETF provides a very convenient way to confiscate everyone’s gold, as it is all in one convenient place, as opposed to various coins and bars all over the world. For now, GLD is a fine trading tool. Use it as you wish. But remember it is paper, not gold. Actually, it’s not even paper. Do you have paper certificates for your GLD holding? It’s in “street name,” which means that you also have the agency risk of your custodian broker.

The new silver ETF (SLV) seems particularly compromised.

James Turk: Can We Trust the Silver ETF?

Of course, if SLV is pretty obviously just a paper trading device, what does that mean about GLD?

Then, there are gold and silver futures, which are obviously derivatives. Actually, these have more of a link with real bullion than SLV and GLD perhaps, as you can take delivery on the contract if you desire.

So, to sum it up:

1) If you want gold and silver, get gold and silver, not paper. This means coins and bars, in segregated, allocated custody with serial numbers and specific weights for large holdings.

2) GLD, SLV and the futures contracts are handy paper trading devices. Use them as you see fit. They are not gold, however.