Using Precious Metals As An Inflation Hedge

In 1971 the United States government closed the gold window and completely took the US economy off of the gold standard in order to help finance the Vietnam War. Since 1971 the value of an ounce of gold has gone from $35 to $1,300.  I do not believe that we will have hyper inflation in this country. I do not believe that we should sell all our stocks and hoard gold in the basement. I think that as an investment gold is a horrible choice. It just sits there. It produces no value.  Having gold and silver is not an investment, but a hedge against inflationary pressure, and may make sense to own in some scenarios.

Precious Metals as a paper asset:

The easiest way to invest in precious metals is to do so in the same manner in which you buy stocks.  There are several precious metals ETFs that can be purchased inside of an IRA or a 401K. Take a look at the GLD ETF and the SIVR ETF, I think it is obvious what their holdings are.  Each fund respectively only holds Gold and Silver. Expense ratios are relatively low because there isn’t active management needed.

The main reason people invest in precious metals inside of an IRA or a 401K is for a hedge against interest rate risk for their bond portfolio’s.  Ric Edelman explains it a bit better than I do, but essentially gold and silver tend to track inversely with bonds at a 10 to 1 rate, thus for someone with a $100,000 bond portfolio, taking $10,000 of it and putting it in precious metals is a sensible hedge.  The goal isn’t to make any money off of the precious metals, the precious metals simply balance out the interest rate risk of the bond portfolio.

One major advantage of investing in precious metals as a paper asset over buying physical gold and silver is tax treatment and accounting.  When buying physical bullion you have to keep detailed records and when sold at a price higher than purchased capital gains tax is owed. Sales tax is also owed in many states when “purchasing” gold and silver bullion.

Precious Metals in physical supply:

Instead of buying gold and silver in an IRA, why not just buy it in physical coins?

The upsides of physical gold and silver:

1. Physical gold and silver are easily recognizable and have been a standard means of exchange throughout the majority of the world for the majority of recorded history.

2. Governments can not create more gold by FIAT, as opposed to just printing more with paper money, although with new mining operations inflation can occur through the finding of more ore.  The shear amount of silver mined in South America in the early 1500s caused damaging inflation in Spain.

3.  As part of an emergency fund silver and gold coins may be exchangeable for goods and services, whereas gold and silver as a paper asset in an IRA will not be.

4. Gold, although being a heavy metal, is a relatively light weight, compact, and waterproof way to transport wealth.  $100,000 today put into gold would be about 74 ounces, or roughly 4.5 lbs, and take up only 6.5 cubic inches of space.

The downsides of physical gold and silver:

1. The biggest downside is the tax treatment and accounting that goes with it for precious metals.  If you buy physical silver/gold/platinum, you must keep track of how much you paid for each piece and when, then when “selling” you would have to pay capital gains on it.  For example, if you bought exchanged Federal Reserve notes for a silver 1 oz coin today you would trade about $25.  In 5 years if you were to purchase 5 gallons of gas with the coin, which could be selling for $70 of federal reserve notes, you would then have to pay capital gains tax on the $45 of gain.  The United States government has a long history of aggression towards competing currencies.

2. The second downside to owning precious metals is that they are certainly a target of opportunity for burglars.  Keeping several hundred or thousands of dollars in precious metals at the house can result in a major loss if you were to get robbed.  You could go with a safety deposit box at a bank, but that requires a bit of trust in the banks.

3.  Precious metals are not really an investment.  They are a static quantity.  If you buy an ounce of silver, next year it will still be an ounce of silver, ten years from now? still an ounce of silver. It doesn’t generate any revenue. With a share of stock you can reap dividends and the value of the company can increase through growth.  With real estate you can receive rents and someone can live in the home. With gold and silver you are only preserving current value (at least hopefully).

4. Prices of precious metals can be highly volatile due to speculation of financial markets.

5. For those who are holding onto precious metals for a true SHTF scenario, whether it is war, famine, or hyperinflation, what do they plan on purchasing with it?  I agree that silver and gold in those scenarios will be worth more than greenbacks, but food, ammo, and medicine will be worth a lot more.  When grocery stores are empty and trucks aren’t running, I can guarantee an ounce of silver will not buy in current dollars 20 bucks worth of groceries. If you have only a week supply of food for your family and the grocery stores are not being restocked, how much silver would you accept in exchange for some of your food?  My guess is no amount of silver would get you to part with it.  I think anyone who is worried about these scenarios should certainly focus on food and security before stocking up on precious metals.

Buying Gold and Silver

Prices as of this writing:

• Silver: $21/oz
• Price of 1oz coin: $25
• Percent over spot: 20%

• Gold: $1297/oz
• Price of 1oz coin: $1,359
• Percent over spot: 4.8%

Gold can also be purchased in 1/2 oz, 1/4oz and 1/10oz coins, which carry higher prices above spot.  1/10 oz coins are $149, 1/4 oz are $363, and 1/2oz are $701.  Gold can even be purchased in 1 gram bars for $52.  An ounce purchased in this fashion would cost $1,471 per ounce.

Basically silver is more expensive to buy in large quantities, but gold is a better value for storing a larger amount of money in precious metals. Silver and gold “rounds” can be purchased for a lower premium over spot price. Rounds look like coins but are more simply made, don’t have intricate designs, and are not issued by governments.

Additional Thoughts:

I think having a small supply of precious metals makes sense as part of an emergency fund. I can see having maybe a months worth of expenses in silver, as well as a months worth of expenses in cash kept in the home, as part of an emergency fund.  This would be in addition to 6 months of expenses in the bank. I think putting 100%, 50%, or even 10% of an entire investment portfolio into precious metals is not a good plan because it isn’t possible for precious metals to generate wealth. Check out this comparison of Gold Vs The Stock Market over the past 7 years.

What about you? What role, if any, do precious metals play in your investment strategy?