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A fool's gold rush? Readers weigh in
Buying gold when it's already run up in price has its risks, as SuperModels readers are happy to point out. But its worth as a hedge against political risk is stronger than you'd think.
By Jon D. Markman
Are investors rushing into gold just as most of the upside has been all but mined out?
Thats what plenty of readers accused me of recommending after my Jan. 29 column, 4 ways to get in on the next gold rush.
Truthfully, the gold bug left me cold until I ran across a news item on Bloomberg a couple of weeks ago. On Jan. 22, the wire service reported that European Union finance ministers had agreed to report foreign savers interest income to their home tax authorities.
While that bureaucratic action might sound like an innocent attempt to wring more taxes out of citizens wealthy enough to have foreign bank accounts, it sounded like a power grab that takes the Continent one step back toward its dark days of totalitarianism -- and is likely to be one more reason that smarter Europeans might turn increasingly to gold as a store of wealth instead of bonds, equities or paper cash.
Offshore havens in places like Switzerland and Luxembourg exist because people -- particularly persecuted minorities, but also the reasonably paranoid rich -- have learned the hard way that governments sometimes do bad things, and it may be a good idea to have some wealth legally tucked out of the reach of your home authorities. If paper wealth is suddenly going to come under greater scrutiny for the sake of a few extra dimes worth of tax receipts, then one of the few alternative options for well-to-do Europeans will be gold.
Readers respond
This potential source of interest in the yellow ore may be one of the hidden reasons that prices have risen sharply in the past two months, from the $320 level at which it traded from September to December 2002, to the current price around $370. To be sure, as I wrote last week, higher gold prices are tied strongly to fear over a war with Iraq. But many experts I have interviewed say the war premium probably accounts for only $20 to $30 of the current price.
On the other hand, I heard from many readers who say that investor interest in gold will fade as soon as the moving trucks appear outside Saddam Husseins palaces in Baghdad.
Said reader Scott E. Butler: Ive been trading/investing in gold for 20 years for my own account. Now is the time to be easing out of ones positions, not scaling in. I keep as much as 10% of my portfolio in gold, in Krugerrands and gold mutual funds, and also buy U.S. silver coins in bags. Gold does well when the market stinks, but you have to trade it. When it goes way up, you have to sell some of it and buy stocks. Soon we will start to hear rumors of mines selling forward and central bank selling, and gold will go back down -- unless we get Armageddon. Selling into this furor to scale back to 3% of your total portfolio (in Krugerrands and silver coins) makes sense to me, not buying more. Unless you sell when prices go up a lot, all your gains will go away. He adds: Dont keep these in a bank since in bad times, the banks will close and the government will confiscate the money. If that happens, gold will be at $10,000 per ounce and silver coins will be worth gold at todays prices.
Wrote Canadian reader Allan Bateman: Up here, gold is followed to a much greater extent than in the United States -- and there are now a million gold-stock scams emerging as investors try to regain their lost wealth from the stock market. They are easy prey. Just like the go-go years in stocks when many investors dropped their savings into the market in the last six months before the crash, so too with new gold investors. Just watch the buying when the price goes over $400 an ounce. If youve never had the pleasure to watch firsthand a real stock promoter at work, it's a sight to behold.
Another Canadian, Bruce Love, wrote: Gold is a very dangerous and volatile market. It's absolutely imperative one looks below the surface and hype to focus on the professional dealers and banks on the various exchanges to have a finger on the pulse of the markets. Otherwise, investors in gold and silver will have a far greater chance of losing money rather than making it.
Andrew Thompson, an investment services associate at T. Rowe Price, was more emphatic: Your article is simply irresponsible. Have we not learned anything from the tech craze three years ago? Investors are easily led astray by articles such as this one. They see someone recommending a certain security or commodity and they immediately run out and buy the closest thing to it -- ignoring their investment strategy. I wonder how journalists sleep at night knowing they're leading a bunch of cattle to yet another slaughter. He would get along with Edward J. Nofer, of San Antonio, who wrote: Your article is an empirically inaccurate, sloppy piece of panic-inducing nonsense.
John Crowley, who identified himself as a consultant on gold to financial institutions and manager of a hedge fund, said major commercial bullion dealers currently have their largest net short position in gold since the first quarter of 1996, when prices peaked at $417 per ounce. They are the smart money, he said. The public speculators, meanwhile, have their longest net long position ever, he said. They are your consummate crowd -- the Johnny-come-latelies who load up at major peaks. Crowley also notes that silver has failed to log in a multiyear high at the same time that gold has done so. This is considered a classical non-confirmation, a warning that we have reached an extreme, he said.
Crowley said he believes gold is going through nothing more than a bear-market rally that has taken prices to a cyclical extreme. A sizable correction is way overdue, he concludes. As of two weeks ago, I dumped all my gold-share holdings and am currently flat. I am now looking to go short the very same shares I owned.
Best way to buy gold as a hedge
Im not ready to recommend that you buy or short gold shares, or buy or sell bullion, but the recent interest does feel a lot like the rally in small-cap stocks around this time last year. They started to heat up in late January 2002 after a big rally through 2001, and carried only through April before petering out.
Yet it is important to distinguish between speculating in the shares of gold-mining companies for the appreciation value, and buying physical gold for its value as an insurance against the depreciation of the dollar and the general decline of Western civilization. To the latter end, I called veteran coin dealer Bill Haynes, owner of Certified Mint in Phoenix, to learn whether hes seen a surge of interest.
Haynes warned, first of all, that the worst way to participate is probably the purchase of numismatic-quality collectible gold coins. The most popular of these are known as St. Gaudens -- U.S. double-eagle coins that were minted in the 1920s. The problem is that their value is very subjective; a single mint-condition coin could go for $700 to $1,100, depending on the scrupulousness of the dealer. Unless you know what youre doing, and go to coin shows on the weekends and study catalogs at night, 90% of the time youll get ripped off by these so-called investment-level coins, he says. Its just a collectible that happens to made from gold. Theyre the favorite instrument of telemarketing scammers. Avoid them.
Instead, Haynes recommends that new buyers focus on new U.S. gold eagle 1-ounce coins produced at West Point by the U.S. Mint, or the Krugerrand, which are 1-ounce coins that generally date from the late 1970s and early 1980s. The U.S. Mint expects to sell about 1.5 million gold eagles this year; you can only buy them through a dealer.
Whatll you pay? Even though the spot price of gold was $370 on Monday, almost nobody pays that price. Generally expect to pay 6% more. Haynes said the most common way for wealthy private citizens to buy gold coins is in bags of 20. The spread is significant. If you called him on Monday, you would pay $393 a coin. If you wanted to sell them on Monday, hed pay you $377. Youll pay a little less for the Canadian maple leaf 1-ounce coin, around $391.50, since its considered slightly less desirable. You might pay even less for a Krugerrand, since its roots in Afrikaner-led South Africa and special IRS treatment make it somewhat less desirable still. If you buy all three, youll notice right away that the maple leaf seems a little lighter than the others. Thats because it is solid 24-karat gold, while the Krugerrand and gold eagle are both 22 karats with a bit of copper alloy thrown in to make them more durable.
Haynes said hes noticed a pickup in demand for coins by sophisticated people -- CPAs, doctors, lawyers who have done their research and are buying for wealth-conservation purposes, not speculation. He compares these buyers favorably with the panic buyers he saw after the terrorist attack in 2001, and during the steepest descent for the stock market in 2000. We do not see a mania; its nothing like 1980, which was pandemonium. However if the price of gold moves above $500, he does expect to see people sucked into the market just as they were sucked into the Nasdaq ($COMPX) as it crested above 4,000 in 1999.
Fine Print
Many readers also wrote to recommend buying shares in the Central Fund (CEF, news, msgs), a closed-end fund based in Alberta. One of them, Stewart McGuire, an investment banker at CIBC World Markets, said the company, for which CIBC recently raised money, stores physical gold and silver in a vault unencumbered, unmargined and unloaned. There is also a small amount of cash on its balance sheet, but no other assets. Central Fund is structured as a public corporation with shares listed on the Toronto Stock Exchange and the American Stock Exchange, but it cannot be shorted. McGuire said the fund is designed to allow pension and mutual funds to take on exposure to the underlying asset even if they would be unable to buy the physical asset because of investment restrictions. To read Central Funds recent disclosures, visit Sedar.com, which is the Canadian version of the U.S. Securities & Exchange Commissions Edgar. Here is a link to the funds annual report (PDF file); and its financial statement (PDF file).
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