Saturday, October 27, 2012

Precious Metals (Gold/Silver) in Australia Exposed!

"Planning to invest in gold? This is what you need to know" was the title of a recent article from Channel 7's David Koch aka Kochie (a well known Australian financial commentator). One thing I found particularly amusing in Kochie's article was the disclaimer at the bottom:
"As always consult your financial advisor before galloping into any gold rush."
How many financial advisors would include self stored (e.g. personal safety deposit box) physical Gold or Silver in their suggested plan for you when they don't receive a commission from the purchase? If you plan to see a financial advisor about purchasing precious metals, find one who charges an hourly rate for his services rather than one who works on commission and make sure it's someone who is familiar with the different ways of getting exposure to Gold and Silver.

The last time I was reviewing my income protection (around 18 months ago now) I asked the financial planner about exposure to precious metals through their boutique firm and got a blank look. The closest they had was a mixed commodities fund.

While Kochie's article did go over a few key points, it was not really helpful for the novice at all (and was more or less a rehash of a very similar article 2 years ago). A much more in-depth guide I wrote last year for buying physical Gold and Silver can be found here (Gold and Silver Buyers Guide), but even this guide has it's limitations, it already assumes that the reader wants to take on the risks and responsibilities associated with owning physical.

The problem with either of the above linked guides (Kochie's brief overview or my guide to buying physical) is that they attempt to put the cart before the horse. Before buying precious metals you really need to have an idea of why you are buying and this will guide you toward the most suitable form of precious metals exposure.

What many people fail to realise is that there is a huge variety of different ways to gain exposure to Gold and Silver, just like property (residential, commercial, buy and hold, renovate, develop, real estate investment trusts, local or overseas purchase) or shares (technical trading, dividend investing, fundamental company analysis or buying an index). The variations are almost limitless when you consider that some people may choose to gain exposure in multiple ways and for multiple reasons.

Here are some questions you may need to ask yourself before jumping into precious metals:

Are you buying to preserve wealth or create it?
Do you consider Gold and Silver to be money or an asset?
Do you have a short or long time frame?
How often will you want to change your position?
How involved do you want to be in managing your exposure to precious metals?
What are your expectations on the value of the AUD relative to the USD?
What level of counter-party risk are you comfortable with?

And here are some of the aims of those who currently hold:

Used for wealth preservation over the long term (savings)
Tool to increase wealth relative to other assets (speculate on changing ratios)
Tool to increase wealth in ounces by trading the Gold:Silver Ratio (GSR)
Trading short term momentum or technical chart patterns for profit
An investment via purchase of profitable mining companies
Insurance to protect from complete currency collapse
A hedge against falling AUD (protect against systematic risk/shocks)

Below is a brief flow chart showing a majority of the ways that you can gain exposure to the precious metals bull market (in Australia). You can't rely on this chart alone to make a decision on which type of exposure is right for you, but hopefully it highlights the diversity of options available:

Precious metals are used by many different types of people, with different views, investing over different time frames and for different reasons, so trying to make a decision on which exposure is best for you can be difficult.

For someone who wants to trade the bull market purely on a technical basis and take short term profits, purchasing physical bullion is probably not the smartest move. In much the same way someone who is buying Gold and Silver in the expectation that they will replace fiat currency following the collapse of the current financial/monetary system is not going to be buying CFDs. Once you've given thought to your reasons and goals for buying precious metal, it usually becomes much easier to decide on the form you buy.

Some precious metal advocates will tell you physical is the only way to go, "If you don't hold it, you don't own it", to which there are varying degrees. For example some feel that physical is best kept in your personal possession, either stored at home or buried on your property. Others who advocate physical think that holding it in a personally organised safety deposit box poses a lesser risk than storing at home. Neither method it without it's risks (for example precious metals stored at home are are at risk of theft or could get damaged in a fire). It's a pretty disturbing thought, but if someone knows you store valuables at home they could threaten you or someone in your family with a weapon to get you to tell them where your stack is, even if buried).

It's not really a surprise that we see opinions like this:
Today gold is traded like a volatile commodity by gamblers who like to call themselves traders. Or else it is held as a small percentage of one's wealth for the expressed purpose of "insurance." Gold is actually a pretty poor inflation hedge as long as it is under external influences such as the inflatable supply of paper gold BB liabilities. So the only way it can even hope to perform as prescribed is as insurance in physical form only. Yet so many investors still hold "paper gold" as the insurance portion of their portfolio. This alone really highlights the confusion in Western "professional" investment thought.

Most people are savers, not investors or traders. Yet today we are all forced to be investors chasing a yield because there is no such thing as a perfect inflation hedge. If there were such a thing, a large portion of the "investing public" would not be anywhere near stocks and bonds. Even the most "risk free" bonds, US Treasuries, have the greatest risk of all, currency risk. And in the case of the dollar, this is exposure to a risk that, today, is well out of the hands of the currency manager thanks to seven decades of functioning as the global reserve standard. FOFOA
When we've seen events in recent history that look like this:
It's one thing for $1.2 billion to vanish into thin air through a series of complex trades, the well-publicized phenomenon at bankrupt MF Global. It's something else for a bar of silver stashed in a vault to instantly shrink in size by more than 25%.

That, in essence, is what's happening to investors whose bars of silver and gold were held through accounts with MF Global.

The trustee overseeing the liquidation of the failed brokerage has proposed dumping all remaining customer assets—gold, silver, cash, options, futures and commodities—into a single pool that would pay customers only 72% of the value of their holdings. In other words, while traders already may have paid the full price for delivery of specific bars of gold or silver—and hold "warehouse receipts" to prove it—they'll have to forfeit 28% of the value. Barrons
The problem today is that any investment or form of savings has an element of risk. In a recent thread on Silver Stackers there was discussion around the difference between gambling and speculation and the following was an interesting take:
Gambling has a crucial difference with speculation: with gambling, there was no risk prior to the act of gambling, with speculation, there was. On the moment someone buys silver, he reacts on the risk of inflation. On the moment someone pulls the lever of a casino slot machine, he just created the risk. He can decide to not pull the lever, and just go away. Speculation is reacting and thus requires insight, gambling is just a random choice, and requires nothing. Pirocco on Silver Stackers
Someone who thinks their cash sitting in a bank account is safe might want to consider the fact they are at risk of their purchasing power diminishing as tax on interest and inflation resuts in a negative real return in some cases. Not to mention the risk of their bank going insolvent. 

While today Australian ADI's are protected by a limited government guarantee, there are still many places that people can park their cash not realising the risk they assume by putting their money in these funds (some perhaps not realising they are not covered by the government guarantee):
The collapse of major mortgage fund Banksia Securities was exacerbated by an apparent failure to adequately account for almost $200 million in overdue loans and repossessed properties.

Banksia, based in Bendigo, was swept into receivership on Thursday night holding $650m on behalf of about 3000 investors, many of them retirees.

The fund operated by raising money from ordinary investors and then lending money to property developers and other businesses at higher rates.

Four weeks ago, auditors for the company approved the group's accounts and raised no concerns about its financial viability. The Australian
For those who have already decided on physical precious metals and are wondering what form to buy it in, checkout this (somewhat tongue in cheek) flowchart from Jislizard on Silver Stackers:

For a more serious breakdown (which includes Gold) you might like to take a look at the section in my guide called "What to Buy" which briefly describes the main physical options available (in Australia) including: coins, rounds, bars and more.

One thing I would implore, if you are going to use "paper" forms of Gold and Silver, make sure you read the fine print. Many of the clauses and risks listed in the terms and conditions booklet can be an eye opener.

This post is not intended as a be all and end all on investing in Gold/Silver in Australia, but hopefully it will get you thinking before making a purchase and reduce the number of people blindly following the advice of others who may not have your best interests in mind and while I can appreciate the irony of having just said that while displaying affiliate links on this blog to purchase physical bullion, I can honestly say that I think it's a good idea for all investors to have at least some of their precious metals exposure in physical.

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