Foundational Precious Metals Post 1 of 2

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Our friends Peter formerly Bayou Renaissance Man and Jamie of My Adventures in Self Reliance have both recently mentioned precious metals. I got to looking and realized I did not have (or could not readily find) a good foundation post on precious metals. So my intent is to write one.

Before getting started it should be noted I am  not a doctor, lawyer, accountant, financial adviser or anything like that. I speak solely of my own experiences, observations and beliefs. You should check with whatever sort of people, officially licenses or otherwise, then make your own decisions. Consider yourself officially disclaimed.

First we should narrow the scope of this post. My intent is to talk about the purchase of physical precious metals. So immediately I am excluding ETF’s and various places that offer to store PM’s for you in terms of purchase options. Next I intend to focus on bullion metals. Bullion being various bars, coins, etc that are purchased for the value of their physical metal content. This is different from ‘numismatic’ or collectible type coins. Numismatic coins carry a value based on their age/ history and condition; a rare 300 year old coin in excellent condition might have a bullion/ melt value (the actual value of the precious metals in the coin) of $300 but a collectible value of $5k. Numismatic coins are a whole different ball of wax and outside the scope of this discussion. We are also not really talking about jewelry. The primary reason we are not talking about jewelry is that it tends not to be a good deal in terms of bullion value and a lot of stuff floating around is fake. The one exception I can think of is for countries where the purchase of non jewelry precious metals is heavily restricted. At that point I would buy simple jewelry like plain wedding bands, bracelets and necklaces but I digress. So we have narrowed the scope of this discussion. Also I guess to further narrow things down I am talking about silver and gold. I am not talking platinum, palladium, copper or my favorite precious metal lead.

As to buying precious metals you can primarily go to a local dealer or an online one. Both have advantages and disadvantages. That is a long conversation. I will note that it is important to consider the complete out the door cost of a given item. Online guys charge for shipping, etc sometimes at high rates. Brick and mortar guys can be a real asset, especially if you want to make a big purchase today. Also the local PM guy can be a pretty handy ‘grey market’ asset. Their downside is often these folks do not treat smaller, normal Joe Everyday purchasers, very well. The premiums some of them charge are ridiculous. As to putting my money where my mouth is on buying PM’s. For the last 3 years or so I have been buying from Montana Rarities and have no complaints though if a local dealer would treat me square he could earn my business in short order.

The pricing of precious metals is a little weird. They are traded on the open market like any other commodity such as wheat or pork bellies. This is called ‘spot price’. That being said spot price does not tell the whole story in terms of precious metals for physical delivery. This is called a premium. It is probably a touch more complicated with a wide array of fees, long term contracts, etc all but we will keep it simple.

Theoretically an ounce of gold is worth spot price when it is a bunch of little flakes in a tiny container. The folks at the South African mint making Krugerrands or any other coin have costs to turn those flakes into the shiny coin we covet. Also they have this crazy desire to make money. Those folks sell the coin along with a bunch of its friends to a dealer. That guy also has costs and a desire to make a profit. Depending on the size of the operation there may be a couple progressively smaller dealers between production and the point of sale to Joe Everyday. In fairness to the people involved in this chain they obviously should be compensated for their efforts and they operate on razor thin margins.

These costs generally represent the premium between spot and the real physical price of a given item. Generally premiums are pretty level. Say it is spot plus 5-10% depending on the item involved. This baseline part of the premium is theoretically static or at least pretty consistent.

However sometimes premiums go crazy. At times we can see significant gaps between spot prices and the actual price of a coin in your hand. Why does this happen?

In general I can see two real reasons. One I know and one I think I have seen some evidence of and tend to believe. They both tend to flow together.

One piece is good old economics 99. The reasons large institutional investors buy (largely paper/ electronic) gold is different than the reasons people buy physical precious metals. If the indicators for institutional investors are down and the indicators for buying physical PMs are up you can get a gap. Think of it like this. The Jim Beam factory had a fire so they are having a rough week but it is Friday night and bottles of the stuff are flying off the shelves inn your town. Also physical PM’s are a surprisingly small market. A modest increase in demand will mean shortages. Pretty quickly this new demand will get built into the market, maybe within a week or two.

The other piece is that arguably there is considerable evidence that big banking interests, specifically Goldman Sachs manipulating gold and silver prices. With those resources it would not be hard to do but this manipulation would not necessarily cross over to the physical PM market.

Why would a person choose to buy precious metals? In my mind there are four readily apparent reasons.

-First is some sort of speculation. Buy low/ sell high, that sort of thing. Though most people do this with ETF’s or such maybe a person might want to physically hold the metals because they are a contrarian investor, have some sort of worst case concerns or something. I am neutral about this sort of plan. It has worked out well for some folks so I am not against it per se, just that it is outside the scope of this discussion.

-Second is some sort of tangible investment but in a more buy and hold kind off way than the first option. I generally like this plan. PM’s do not grow via compound interest the way some other investments might. On the other hand when you look at compound interest and factor in inflation the tale is a bit less favorable to those 3-4 percentage points a year. It is said in the time of Shakespeare an ounce of gold would buy a fine men’s suit and it still does. If you wanted to stash say a few grand (or more) for ten or twenty years especially if the local currency is unstable or you see bad times coming PM’s would be a good way to go.

-Third is as a hedge against inflation or a currency collapse. We will get to it later but I really like PM’s in this context. A situation with high inflation or maybe even a currency collapsing but where the fabric of society doesn’t entirely break is where I think PM’s thrive.

-Fourth is for some sort of mad max type scenario. I do think silver and gold would be traded in this type of scenario but that their value would pale in comparison to say fishing hooks, AA batteries, condoms, etc or especially .22lr, various 12 gauge ammo or guns (purchased for good prices and thoughtfully sold with a decent holster/ sling a few boxes of ammo and if applicable a few mags). In this scenario a person would be most prudent to be thinking past the immediate event a year or two to the recovery which of course implies you have put considerable energy and resources into getting to that point, then put some money into a big ole bag of silver or 5 and as much gold as they can afford.

Maybe we could say there are some other reasons but one could probably generalize them under one of the ones I mentioned at least for the purpose of this conversation.

Something The Money Changer said is worth mentioning here. I think he stays heavy on silver for longer than I would but still generally good advice to consider.

So we have talked a bit about precious metals and briefly described the reasons a person might choose to purchase them. Those reasons matter because different purposes are best suited by different kinds, or at least quantities of silver and gold.

Let us talk about the pro’s and con’s of silver and gold in general, before getting to specific products.

Silver:
Pros
- Affordable. Right now spot is around $15 which puts a generic 1 ounce silver round a shade under $18 and pre 64 US Coinage 90% is at about 16x face. (This is slightly skipping ahead to specific products but my goal is to illustrate affordability here which necessitates it.) Assuming you are not a homeless junkie these are prices at much anyone can get into precious metals. Buy an ounce or two every payday and over time it will add up.

-Divisibility. The smaller dollar value per bar/ coin make silver the small bills of the PM world. If you wanted to trade for a weeks groceries either strait across or, more realistically, by selling some coins to a dealer then using the cash to buy the groceries a few ounces of silver are the ticket, not an ounce of gold.

-The small dollar amounts involved let you start off small. There is a reason a baseball player doesn’t start with the NY Yankees, a lawyer doesn’t argue his first case to the supreme court, etc. This way when you screw up, which you will (spending way too much on shipping, pay a silly premium to a local pawn shop, etc) the real dollar amounts involved are negligible. Ten percent screw up factor in a couple hundred bucks of silver purchased while you are learning is the cost of a pizza. 10% screw up on a 10k USD purchase after you unload those jet ski’s hurts.

Cons
-Heavy/ bulky. You do not need to have too much money in silver for it to get heavy and to a lesser degree bulky in a hurry. A decent normal guy stash of 3-4 grand in silver is going to be heavy. Much more than that and it gets quickly into wheel barrow/ pick up truck territory. If your goal is to have a whole bunch of silver to trade for things over the long run this is a good thing. The downside is if you have to go somewhere.

I know a guy who has a lot of silver. He is well past wheel barrow territory and deeply into pickup truck territory. If he needed to move in a hurry, say to avoid a natural disaster or some sort of crime thing, a good chunk of the weight his truck could take would be silver. Obviously if he could only leave with a backpack the vast majority of that silver would have to be left behind. Now if he had half or two thirds of that value in gold it could fit in a small pouch in a day pack.

Gold
Pros
-Compact. An ounce of gold is worth about $1,200 bucks. A little tube holding 10 ounces of gold would be worth $12,000. You could fit that in a pants pocket.

-Recognizably.  Gold has a weird almost magical attraction. A fractional gold coin might just get you through a checkpoint you are not supposed to get through or convince a crooked official to look the other way.

Cons
-Compact. Think being in a store that only accepts bills under $20 with a hundred. In some scenarios making change could be very difficult so at a minimum your negotiating power is bad and at the worst the price of the thing could just become the coin in your hand.

You probably noted that the pros/ cons of silver and gold are polar opposites. Both have valid roles and they compliment each other well. For pretty much every scenario a person will end up with some mix of gold and silver.

As to the ratio between them.

On the lower end it favors silver. A guy who has a few hundred bucks to put into PM’s should probably jut buy silver.

Long term trading favors silver.

If portability and extreme compactness are issues then gold is the way to go.

On the high end it favors gold. If a person had a bunch of money, either in one shot or over time, to put into PM’s the compactness of gold is needed.

I am going to break this into a 2 part post because I am tired of writing and need to get something up since it has been a few days. In part 2 I am going to talk about specific types of gold and silver products and throw out some recommended ratios/ products that might fit different needs.