Gold Under The Microscope
This is the last installment of a five part series on gold.
In the prior installments of this look at gold, I discussed the basic premise of investing in gold in the current environment, and the forces pulling the gold price in different directions. Today I'll discuss some specific gold investments.
To own a stake in gold, there are four main choices:
Hold the actual physical metal in the form of bullion, coins or jewelry. Own shares of a mutual fund or exchange-traded fund, exchange-traded vehicle or exchange-traded note that holds gold in physical form. Hold gold derivatives, either directly, through options, or indirectly, through managed funds. Own shares in gold mining companies directly, or through funds, etc.Let's look at the pros and cons of these various vehicles.
Miners suffer from cost pressures, like energy and labor, to which the metal is impervious, but mining profits may grow at a faster pace than the metal as the gold price accelerates. However, that has generally not been reflected in the price of mining stocks in recent years.
The physical metal shrugs off mining costs, etc., but leaves the investor the problem of storing it safely. Also, you may pay a premium of up to 15% to a dealer when you buy it, and take the haircut again when you sell it. Then it is taxed as a collectible, which takes a bigger tax bite than a capital gain on a stock.
Gold invested in ETFs and various types of mutual funds either have the collectible tax problem or the eternal mutual fund problem wherein, if you're not careful about when you buy and sell, you may end up paying capital gains taxes on profits someone else made and you didn't. Which of these perils you face depends on how the fund is structured.
Sprott Physical Gold Trust ETV (PHYS) is not taxed at the collectible rate, but is subject to the latter negative possibility. Sprott allows redemption of shares for actual bullion, subject to minimum requirements, which, however, are quite high for the average investor. The minimum amount varies, but is usually between 350 and 430 troy ounces.
ETFS Physical Swiss Gold Shares (SGOL) and StreetTracks Gold Shares (GLD) both are taxed as collectibles, but avoid the mutual fund danger noted above. I favor SGOL over GLD because it stores its gold in Swiss vaults, where one might suppose it is safer from the threat of confiscation by the U.S. government. During FDR's administration, the owning of gold by individuals was outlawed. Don't think it can't happen again.
By the way, all the "E" (exchange) vehicles are subject to some tracking error over an extended period of time, wherein the ETF, etc., does not quite track the price of the underlying asset. This error can be especially great in levered funds that aim to double or triple the performance or inverse performance of the asset. You should read the prospectus of any ETF, etc., carefully before investing.
The ETFs and funds that hold the physical metals all may have one other problem: We aren't in a position to audit their vaults to verify they really have the gold. Some companies do issue reports from outside auditors. We have to take it on faith that what they say is true. I have no information that would suggest it's not, but in today's world, and with the events in the world of finance in the last few years, one would be foolish to at least not consider that possibility. To the extent any of these holdings is backed by an over-the-counter derivative instead of actual metal, we are subject to counterparty risk. Think AIG, Lehman Brothers, etc.
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Exchange-traded options, on the other hand, are cleared through the CFTC, and your counterparty is required to hold adequate collateral. Still, if the option is on an ETF, you're back to the problems we just discussed. In addition, options are highly volatile, and can go to zero if your timing is wrong. That holds true whether the option is on an ETF or a stock of an individual mining company.
Which brings us to our next and final subject in this series…
Gold Miners
Of all the forms of gold one can invest in, the miners have been beaten up the most. At some point, they will probably represent the best buy. That being the case, let's do a little prospecting.
Following are a few miners that have various virtues to recommend them. It is extremely rare to find a perfect stock of any sort at a good price. Companies with the best growth outlook usually have stratospheric P/Es by the time we realize their potential. Very solid, low P/E companies usually have slow or uneven growth. These principles hold true with the gold miners, but in spades. Mining is an inherently "lumpy" business, with year-to-year results less predictable and more subject to risk than most other industries. Quarterly results are a real crap-shoot.
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