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Friday, October 8, 2010

Gold Doesn't Have To Weigh A Ton...

With the precious metal bull market in full swing you dear reader like many may be considering putting a portion of your portfolio in to bullion.  Many investment advisers recommend you put a portion of your investable assets, usually between 5 -15%, into gold and or silver to protect from inflation, deflation and currency debasement. We do live in a volatile era and gold does serve as a store of wealth and an insurance policy against financial turmoil. The precious metals have been rising for 10 straight years and will in all likelihood do so again this year. The point of this post is to address the issue of buying the bullion not to detail all the reasons why it is needed or why contrary to what most people think it has not come anywhere near a peak.

The precious metals complex is not for the faint of heart as they can and do gyrate with down swings of 10 -50% in the metals and the shares usually 30+% depending on market cap and other factors.  It is highly advisable to purchase a bullion stake as it is a savings vehicle and cannot be printed so it is a store of value. Once you have your bullion allocated and paid for then you can consider putting some capital the mining shares. The shares do have counterparty liability as they are shares of a company and many things can go wrong in a company unlike a bar of metal. Investing in the metal is going to preserve your wealth where as holding the shares can make you wealthy but you accept more risk.

Many people don’t want to just go out and buy bullion for the following reasons:

1)      They don’t know where to buy it.

2)      They don’t know what to buy.

3)      They think it is too expensive.

4)      It is heavy to transport.

5)      They don’t have a place to store it.

There are alternatives to buying the physical bullion at a coin shop and tossing it in the trunk of the car, weighing it down so the bumper is dragging on the ground. One can buy physical gold on-line through your brokerage account with the click of a mouse.  The options for gold ownership beyond bullion are Exchange Traded Funds(ETFs), Closed end funds and lastly digital gold.

The ETFs are SPDR Gold Trust(Nyse:GLD), I-Shares Gold ETF(NYSE:IAU), I-Shares silver trust(NYSE:SLV) which are all designed to track the price of gold or silver with the least expense and trade like stock on the US exchanges.   There are a couple of closed end funds that act similar to the ETFs but they are governed by the Investment Company Act of 1940 in a similar fashion to a mutual fund, but they trade on exchanges. The closed end funds are Central Fund of Canada (NYSE:CEF) and  Central Gold Trust (NYSE:GTU) The last option is digital gold using goldmoney.com, which not only  allows you to invest directly in gold, silver, and platinum but also choose whether you wish for it to be vaulted in London, Zurich or Hong Kong.

The ETFs and Closed End Funds are very easy to purchase right thru your brokerage account since they all trade on the NYSE it is no different than buying IBM or McDonalds. They are very liquid and run efficiently.

There have been questions raised over the years about the gold held in the ETFs as to whether they actually have it or whether it is double or triple owned because it is unallocated. I believe after reading the prospectus that the ETFs hold the gold in an allocated fashion and do not loan it out. The concern that I have is derived from the great depression when gold was confiscated from the general public to revalue it in order to stem the deflation. I do not believe that the US Government would recall the gold from individuals this time as they can easily lay claim to the sixth largest stash of gold by nationalizing GLD. For example, the gold in GLD is held allocated in London, but the fund is run by a US corporation and trustee. In a time of crisis the government has demonstrated its ability to abrogate the law and just seize as they did to the bondholders of GM. It is due to the rapaciousness of the US Government today that I choose not to invest in the ETFs for bullion exposure.

I have chosen to utilize the Central Fund of Canada (CEF) which gives me exposure to both gold and silver that is allocated and stored in Canada, run by a Canadian company. The fact that the Gold and Silver is located outside the US gives you geographic diversification and the structure of the company as a foreign entity provides you protection against seizure. The same goes for the closed end fund called the Central Gold Trust (NYSE:GTU) with the exception that it only invests in gold.

A concern you should have when in the market to buy a closed end fund is that you have to be aware of the discount/premium to NAV. In other words when the fund is hot and the underlying assets are not keeping up with the price jumps you will pay a premium which can cost you dearly if the underlying asset declines in price then the premium can vanish as the price and your investment value goes down. The trick is to buy when the closed end fund is trading at or close to a discount. In this case since the underlying asset is in a bull market even if you make the error of buying with a large premium you will get bailed out by price rises but your overall return will be less.

As I write this blog the premium on CEF at current gold prices is 5.9% which is below its 10 year average of 7.03% and just slightly above the 5.5% premium to buy an American Eagle today.  CEF has not traded at a discount since about 2001 and while the premium has been lower at times it also has been over 21%. If you believe as I do that gold and silver will trade higher then buying when the premiums are comparable to buying America Eagles makes sense. One also has to factor in to the premium that the fund is roughly 45% silver which has a higher premium when purchasing. Conversely, if you want to buy just gold then Central Gold Trust(GTU) affords you the exact same benefits as CEF, except it is a monometallic composition. At the time of this writing the premium on GTU is a paltry 2.6% over the spot price, which means that on a cost basis you can acquire bullion protection for less than or equal to buying bars directly from a dealer and you get the benefit of storage and liquidity.  GTU is the value at the moment, however, GTU currently not as well known as its cousin CEF; this translates into volume of only around 90K shares per day. If you need liquidity for a large position then CEF is the choice here but if you want value and are looking for a long term holding correlated to gold(because it is gold) then GTU with its low premium make sense.

If you are interested in following the premium of CEF then you can follow this link to an online calculator. The results from the calculator are pretty close, but there are discrepancies as one of the components is cash and the level of cash varies in CEF even though the calculator dosen’t. I have not found a similar calculator for GTU but one could put together a spreadsheet in excel pretty easily.

One other advantage of CEF and GTU is that they are structured as PFIC (Passive Foreign Investment Company)  for US investors from an IRS perspective. Since they are PFICs you can file a QEF(qualified elective form…IRS Form 8621) which allows you to be taxed at the regular capital gains rate rather than the collectible rate currently pegged at 28%. The IRS considers all forms of gold as collectibles; this includes numismatics, bars, coins, rounds, precious metals held in secure locations like Goldmoney or Bullion Vault. ETFs have their own tax rules as do closed end funds. This is not a simple topic, nothing where the IRS is involved is ever simple, and one should consult with their investment advisor to take advantage of the lower tax rate associated with PIFCs when dealing in CEF or GTU.



Moving on to Goldmoney.com, which is a “Digital Gold” site. Goldmoney is an online gold holding company founded by James Turk a well known and reputable individual in the gold trade. Goldmoney provides the protections of CEF and even better geographic diversification as you can choose from 3 different country locations to store your allocated gold, silver or platinum. The premium structure is very competitive with buying the bullion outright, but you have the added ability to convert your holdings to different currencies if you desire as well as make payments to vendors that accept digital gold. The drawback to Goldmoney is that it requires paperwork to set up the account and then once it is set up you have to fund it via wire transfer. Additionally, Goldmoney only allows 90 days from receipt to invest the money in metal, after which they wire it back to you account to prevent timing the market I guess.

So to get real non-paper bullion there are cost effective options and they won’t weigh you down.

Disclosure: I am long gold via bullion, CEF gold stocks and goldmoney. I also have positions in other sectors not just precious metals.



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8 comments:

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