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ON THE HIGH COST OF OWNING PHYSICAL GOLD &
SILVER:
THE VALUE OF A KISS:
There are many ways to
own gold and silver, and some, I will be the first to admit, far
cheaper than physical gold and silver. Options, futures,
mining stocks, or warehouse receipts all carry lower transaction
costs than physical metal. Clearly, that ought to be the
case. All these forms of paper gold and silver cost their
originator no more trouble than scooting around electrons in a
computer, or shuffling paper from one side of a desk to the other.
Not so with physicals. No only must somebody do all the work of
documenting the transaction similar to paper metals, but someone
must also warehouse the physical metal, insure it, provide security,
then physically pull, pack, and deliver it. But life is more than
transaction costs. Look only at that and you risk overlooking the
chief advantages of holding physical silver and gold in your own two
hands.
“ LIKE” IS NOT “SAME AS
First of all, there is
no substitute for physical gold Certificates are not gold. Gold
notes are not gold. Futures are not gold. Options are not gold.
Mining stocks are not gold. Electronic gold currencies (“E-gold”)
are not gold. All of these are “claims on gold,” which is
not gold, but a claim. All of these ownership mechanisms
interpose an extra layer of risk between the owner and his
gold. All history teaches us that from time to time the extra risk
layer explodes, leaving the owner without his gold. There is no
substitute for owning physical gold. Obviously, all that applies to
physical silver as well. Buy physical metals first,
and only then branch out into the other forms.
BUT GOLD & SILVER PAY NO
INTEREST
AND CARRY EXCHANGE RISK
How should we view the
transaction cost of owning gold? After all, physical metals pay no
interest while you hold them, and they also risk a price drop. For
a fit contrast, we should compare the cost of holding metals against
the cost of holding US dollar denominated assets. From February
2002 through September 2002 the US dollar index dropped from 120 to
105 (today, 11/12/02), approximately twelve and a half percent
(12.5%). Setting aside for a moment gold’s gain from February 2002
through today and assuming that gold had remained flat during this
period, what would holding gold have cost? Anyone swapping dollars
into gold in February and back into dollars today would be (12.5%
-7%) = 5.5% better off in physical gold, even assuming a 7%
transaction cost. While for short periods fiat
currencies (like the US dollar) may actually rise against gold, over
the long term their course is uniformly down, so there is always
an inherent cost in holding fiat currencies. Naively remaining in
US dollars does not avoid currency risk – it just
concentrates all your risk in one currency.
WHAT ABOUT DOLLAR
DENOMINATED ASSETS?
What is true of fiat
dollars against gold is also true of fiat-dollar-denominated
assets such as equities and bonds. What performance did
dollar-denominated assets need to post last year to beat physical
gold? In the past year dollar denominated assets had to rise by (1)
the fall in the dollar less gold’s physical transaction cost, and
(2) the rise in gold itself. Thus if a dollar denominated asset has
remained unchanged since February 2002, it has actually lost against
gold even including the transaction cost. It had to rise by at
least 5.5% (to make good the loss in the US dollar in which it is
denominated), PLUS the rise in gold for the period of approximately
$323-$290 ($33 or 11.4%). What’s the bottom line? In rough terms,
over the past nine months any paper denominated asset which has not
gained at least 16.9% has lost money against physical gold,
even including transaction costs.
THE LARGE SPREAD ON GOLD
AND SILVER
Compared to paper
investments, the “spread” – the difference between the “buy” and
“sell” prices for physical metals and every investment– is large,
but not meaningless or arbitrary. Costs arise from moving and
securing physical metal, costs not incurred by moving electrons
around in a computer. To make a sound investment decision, you have
to weigh the cost of owning physical metal against the
benefit of owning physical metal. The chief benefit is having
in your own possession and control at all times the ultimate
liquidity, the value of all values, the self-authenticating
asset. That benefit has a very strange value curve. Most of the
time that benefit is nugatory, because most of the time there is no
panic to chase every frightened soul in the herd into ultimate
liquidity’s safety -- most of the time. However,
occasionally that panic does arrive, and whereas before the value of
actually holding physical metal was trivial, under panic conditions
its value become almost infinite. Owning physical metal is just
like owning a parachute – it’s just clumsy luggage until you really
need it.
SOONER OR LATER
From the futures markets
comes an old saying: sooner or later everything comes back to
physicals. In our modern age, where irreal abstracts and
imaginary derivatives have been substituted for real values, we find
that proverb opaque or quaintly out of date. But the mistake is
ours. Only reality remains real, and not our abstracts and
derivatives.
A wife’s kiss always
beats a wife’s letter.
— F. Sanders
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