Gold Prices Dropping

You may have noticed that the price of gold and silver has taken a fall in recent months, with gold plummeting significantly just in the last few days.   One big factor in this loss of value is that ETFs and other market investors in gold and gold futures are selling off and –

Hm?   Oh, you thought gold was immune from the ebb and flow of “imaginary money” of the stock markets and federal reserve?   You might want to look back and remember that in 2003, when gold Exchange Traded Funds started being traded, the price of gold has gone up five-fold.  For the most part, investing in gold is a commodity market, with a limited supply and varying demand.   Not much different than grain futures and the like; when the dollar gets weaker or demand goes up, the price increases.   That’s nothing inherent in the object; that’s the benefit of investment.    When gold ETFs came on the market, suddenly demand went up; coincidentally, over those same years the value of the dollar dropped, causing the price of gold to inch higher.

Gold’s perceived immunity from market fluctuations is that, because it isn’t consumed or renewed, there’s a level of stability to it.  Up until 2003, if you bought gold in the seventies and sold it at a 2003 price, your return would have been pretty close to inflation.   The past ten years have resulted in growth beyond inflation, so that’s where everyone got so interested, driving up demand and prices.

So, what goes up comes down:   if the selloff of ETFs is any indicator, demand for gold is dropping, and so do prices.  The world economy seems to be recovering, which will reduce inflation.  I highly doubt that the price of gold will suddenly return to 2003 prices (or lower), but there’s likely to be a correction back down below $1,000 sometime soon.

So, should you sell now?  Well, if you bought recently, no; you’ll take an unnecessary loss.  Wait another ten years, you’ll do OK (although not as inflationarily well).   If you bought five years ago:  maybe (and I’m not your financial advisor, so do your own research) and take your 100% profit out, invest it somewhere safe, and in a couple years buy when things look at about the bottom of the curve.   If you bought gold more than ten years ago:  you’ve waited this long, you must have a reason; this is a blip in the long-term increase in the price of  gold, a boon for those who were watching closely, but every investment sees sudden, huge gains and quick loss of value, and that’s exactly what long-term investing is supposed to ignore.

But, now, when should you buy?  If you want to use recent evidence as an indicator for the future, wait until the price has dropped significantly, then start watching ETFs and futures and look for expectations of a rise in demand.  Look at the U.S., China, and European economies, watching for excessive borrowing and printing of that “imaginary money” gold investors so fear.   The increase in demand combined with economic slumping and coated in a creamy shell of inflation is the ripe time for gold prices to rise; when you can check those off your list, that’s a time to buy.

Invest In Gold Coins

I’ve had my bouts with insomnia and I’ve seen the infomercials.  Invest in gold! they holler, the interviewee proclaims the dollar is experiencing its death-rattle and gold is the only sure thing, and the interviewer reacts with shock and disbelief. In the end, all are convinced that buying gold is the only way to avoid financial ruin.

If you want to invest in gold, though, you don’t just buy nuggets:  the places selling you gold are selling it in the form of gold coins.  And not even just gold tokens or gold medals, these are coins from national mints, with a face value printed right on them.

Why are coins the medium for gold investment?  Why not order up a fifty pound gold bar to bury in the back yard?  Or why not as gold rings or necklaces?

A Responsible Gold Investor

One major reason is because a stack of coins are much more easily divisible into smaller units than a gold brick is.  People with the money to buy entire gold bricks, all at once, have the money to do much more practical investing than buying gold.   The guys advertising on TV and in the back of Smithsonian magazine are counting on small-time beginner investors, people with only a few thousand dollars to get started.  They can more easily send out a couple gold Buffalos than break down raw gold into the correct unit.

And this is mostly because the people most trustworthy in breaking down gold into units are…national mints.  This is why other gold, like rings or tooth fillings,  aren’t hoarded and traded as much.  When the U.S. Mint or the Australian Mint or any trustworthy mint produces a gold coin, they are certifying its weight and purity, and they are much more accurate than a jeweler or the guy at the coin shop.

Silver is a bit of an exception here: silver is cheaper and more accessible, so a lot of private mints produce silver coins in specific weights and values.  Note that the “invest in precious metals” people still push national-mint silver dollars as much, if not more, than private-mint silver.  There’s still something to having a coin from a national mint which gives greater assurance of value.

These companies selling gold and silver aren’t selling at scrap value — of course not, they’ve got to make money, right?  Private mints build in seigniorage, a cost of minting, and coin dealers are working on a collectible value for the coins, and everyone adds a “premium” or a profit in the coin’s sticker price over and above the scrap value.

To figure out how much profit is built into the coin you’re buying, you need to do some research and math.  Let’s take a 20-Franc “Rooster” coin.    A Rooster weighs a little more than 1/5th ounce (0.2063 to be more exact) of 90% pure gold.   Multiply those together, and a Rooster has 0.1856 ounces of pure gold in it.

20 Francs was worth $4 USD at the time

Today, gold is $1,580 an ounce, so multiply this number by the ounces of pure gold and you get $293.25 worth of gold in a Rooster.   That’s a nice chunk of gold, affordable by the average gold investor.

Here’s the more subtle reason that the companies selling gold deal in coins:  when the price of gold drops, the price of a coin doesn’t have to.    You’re not buying elemental gold on a commodity market, you’re buying a coin on a collector’s market.  Regardless of the price of gold, a collector will pay around $330 to $350 for a Rooster on today’s market.  The price of a Rooster won’t drop because the price of gold goes down, it changes because the value of the dollar goes up.  The retail market is influenced by inflation and deflation of the dollar, just like other products.

So, let’s talk about the $293.25 of gold in the $330 Rooster.  In order to recover the $36.75 premium in the purchase price, the price of gold has to go up 12%, or get to $1,770 an ounce.   It’s no coincidence that’s about the highest price gold has gone for ever — in late 2011 an ounce of gold went over $1,800, but for the most part has been hovering between $1,500 and $1,700 for the past year.  You might think that buying directly from the U.S. Mint will be cheaper, but the Mint has a pretty specific pricing schedule that runs about 20% to 30% seigniorage and premium.

This doesn’t mean it’s a bad idea to start buying gold as an investment against currency devaluation.   What it means it that there is a very simple way to tell whether your investment will have the opportunity to recover;  controlled inflation is the way of the future for every central bank it seems, so over moderate timespans of five or ten years it’s entirely possible for gold to extend above $1,800 an ounce without wholescale financial collapse.  But investing isn’t about hoping someday to recoup your cost of investing — you want to make a profit, right?

The key isn’t only to just pay a small premium on your gold coins.  If the price suddenly jumps today to $1,800 an ounce and you go buy up all the $330 Roosters you can find, you still run the risk of the price of gold dropping back down to $1,500 and losing your value.   The key is to buying gold while the price is down, and making sure you are paying as small a premium as possible.  12% is pretty high for a gold coin; 2% to 5% is much more desirable, because that’s an inflationary percentage and the market will easily recover that amount for you if you buy when the market is low.  Watch when buying in bulk, too: the assumption is that the seller can take a smaller premium if they’re selling you ten or twenty coins at once, but often the opposite is true because they expect you to not to check the price very closely.

You can successfully invest in gold by using the math shown above.   If you want help doing your math, Coinflation runs the gold-value calculation for you.  The companies that are pushing the fear-based gold-investment market are banking on the fact that the investors will pay much higher premiums out of fear.   Use your math skills, and when you buy gold coins make sure you are paying the lowest possible premium on the value of the pure gold the coin contains.    If you’re in the market to buy gold, make sure you know what gold costs, and don’t pay more than you have to.