There are many financial debates, but for me, none of them are quite as enjoyable as watching gold bugs beat up on each other. This is particularly true when it comes to the debate of owning physical precious metals directly or through an exchange-traded product (ETP).
Let's take a look at each side of the gold debate and how it impacts your own personal gold standard.
Owning Physical MetalsInvesting in physical precious metals (NYSEArca:GLTR - News) may seem easy enough but can pose a labyrinth of choices. Do you buy gold bars, coins, or jewelry? (My wife prefers jewelry, while I prefer watching movies about gold, like the "Treasure of Sierra Madre.")
In the case of coins, a number of perplexing things can happen. For example, coins with the same amount of gold can trade at different prices.
For the 2012 series, the American Gold Eagle ($1,795.29), Canadian Gold Maple Leaf ($1,762.09), and South African Krugerrand ($1,791.89) are all quoted by major coin dealers at different prices, despite the fact that each coin contains the same one ounce of gold. Meanwhile, the spot price of gold is around $1,700 per ounce. Why the discrepancy in prices?
A "coin premium" is the additional cost of a bullion coin above the market price of the precious metal it contains. This additional expense occurs for a number of reasons, including the costs incurred by the mint producer to manufacture and distribute the coin. And because the American Gold Eagle, the Canadian Gold Maple Leaf and South African Krugerrand are each produced in different countries, the minting cost is different, which partially explains the difference in coin prices.
"Mark-up" is another factor that affects your investments in bullion coins. For a retail person, the "mark-up" is the amount above the coin's wholesale price, which a coin dealer uses to make profits. These "mark-ups" can also be affected by the quantity of coins you propose to invest in.
Finally, the question of supply and demand or collectability of a coin always impacts its price. Coins that are rare or were produced in limited quantities can command prices that easily exceed the value of actual bullion they contain.
Investing in physical gold bullion should be straight forward, but for a variety of reasons, it's not. Other knocks against owning physical bullion are the additional costs of storage and insurance. These are legitimate costs that reduce an investor's return that shouldn't be ignored. Despite these shortcomings, owning physical bullion as part of a larger investment strategy shouldn't be ruled out.
Physically Backed Gold ETPs
Launched in 2004, the SPDR Gold Shares (NYSEArca:GLD - News) has approximately $70 billion in assets and is the most actively traded gold exchange-traded product (ETP). Each share of GLD aims to reflect one-tenth the London P.M. fix price of gold bullion. For a modest annual fee of 0.40%, GLD shareholders get intraday liquidity and can save themselves the additional expenses of storage and insurance. For cheapskates, the iShares Gold Trust (NYSEArca:IAU - News) has the same strategy as GLD, but charges a lower annual fee of just 0.25%.
The underlying shares in GLD cannot be exchanged for the physical gold bullion unless you own at least 100,000 or more shares and work with an authorized participant. At today's prices, that means you'd need around $16.5 million invested in GLD. Additionally, you will not be able to see the actual gold behind your GLD shares – you'll have to trust they exist. That automatically makes gold ETPs a bad choice for conspiracy types.
The storage location of the physical bullion held by ETPs or the custodian itself is usually a point of contention between physical bullion do-it-yourselfers and ETP advocates. What happens if the custodian goes bust? What happens if the country where the bullion is stored goes to war? What happens if the gold gets contaminated by radiation like in the movie Goldfinger?
Certain ETPs attempt to reduce these risks. And the idea of diversifying a person's gold ETP holdings among various custodians and in various geographic locations is the general idea behind products like the ETFS Physical Swiss Gold Shares (NYSEArca:SGOL - News) and ETFS Physical Asian Gold Shares (NYSEArca:AGOL - News). Instead of storing the bullion in London or New York, these ETPs hold it in Asia and Switzerland.
I believe the principal benefit of having your precious metals stored in various locations around the world is mainly psychological. For some individuals, living close to the storage facility or in the same country of storage, gives them peace of mind.
A Question of Income
What is your personal gold standard? In deciding the best format for gold ownership, each side of the physical bullion vs. bullion ETP debate has legitimate arguments and each group is in its own way correct.
I like to focus on another uncomfortable fact that both sides of the gold debate typically miss: physical bullion generates no income. And because gold produces zero cash flow, it presents a major conundrum for retirees or investors whose main investment goal is income.
ETFguide's April Gold Income Trade located in the ETF Profit Strategy Newsletter shows you how to use a simple options strategy in conjunction with bullion backed ETPs to convert your gold investments into an income producing asset.
Instead of waiting for gold to reach $2,000 an ounce or some other mental figure, options can reduce the purchase price of your investment along with risk. It's a novel strategy that too many gold investors aren't using.
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