- Multiple events during 2008 to 2013 consistently proved that investing 1/10 in physical gold is usually a sound idea, although the net benefit of holding more is less certain.
- However, physical metal ETFs carry more concentrated custodial risk than equity ETFs. This risk is best minimized by custodial diversification.
- Also, investments in gold mining and physical silver are somewhat like "gold kryptonite": lacking beneficial value, and in addition, neutralizing the portfolio-hedging superpowers of any gold held nearby.
- "Ten good metal ETFs" are listed below, followed by "ten basic tips and perspectives," including "hedging your gold" and "no-fee trading.".
- At the bottom is an argument that oil production is a more sensible investment than metal mining, if using ETFs and trend-following.
A. Why to buy gold: the 2013 bearishness for metals during bullishness for stocks strengthened an argument for physical gold--but also weakened any argument for gold mining or silver.
If you had rebalanced annually between gold and hardcore equity ETFs such as VBK and XRT, the gains on stocks could have paid for either outright losses on gold or for Put premiums--hence you need not have been much affected by the 2013 metalmageddon. Nor do Puts on gold engender any de facto counterparty risk during a stock market rally. In contrast, both non-derivative stocks and their hedging derivatives might have lost -90% of value during 2008 if not for the banking bailouts. Concurrently, both liberals and conservatives are popularly opposed to future banking bailouts--and meanwhile banks are disabling the protective measures of Dodd-Frank.
Warren Buffett was insightful but incomplete in terming gold investing as "going long on fear." Gold is not a precise hedge against the stock market, but is more like a "fourth alternative." The other three are the US stock market, the non-US stock markets, and US Treasuries. By most accounts, including the official cheerleader of the economy President Obama, the US S&P has had an historic rally in spite of a "fragile economy." One reason for this incongruity is that the Eurozone (NYSEARCA:EZU) has repeatedly been hit with far worse scandals, and the Chinazone (NYSEARCA:EEM) is still like a volatile and dependent teenager living with parents. The US is not strong but is "less weak" than Europe or Asia--therefore the US attracts money--therefore this attracts momentum.
The principle of "relative lack of insecurity" seems to explain why, until January of 2013, both gold and US Treasuries continued to put on a strong face, years after they were precariously overbought. The coup de grace for both gold and US Treasuries was the consistent S&P rally of 2013--which in turn seems largely due to a "relative lack of insecurity."
Every investment is partly a game of musical chairs, with fear and greed playing the music. From around 1957 to 2007, so-called "value investors" such as Warren Buffett became ever-more wealthy by placing total faith in an ever-rebounding and ever-overvaluing economy. The non-rebounding EZU is like handwriting on the wall, warning us that an era may be up. Only gold has a chair glued on the bum: its fundamental value is itself. Consequently, a savvy gold investor might not care much about a major gold market fall, just so long as it is not during a major stock market fall. Indeed, there might be nothing healthier for gold than for its bubbles to burst in-between stock market recessions.
Paradoxically however, gold mining and all silver investments are anti-gold: not only weaker than gold, but also weakening to the benefits of holding gold. Gold mining (NYSEARCA:GDX) adds greater losses to your portfolio than the average stocks when stocks lose severely and greater losses than gold when gold loses severely. Adding another paradox, physical silver is bad (NYSEARCA:SLV) and silver mining is not-as-bad. Why hoard a metal that loses more than the stock market? And for US residents, pay extra taxes to boot? In theory, silver has more fundamental value than stocks. So--perhaps someday stocks will drop -90% while physical silver only drops -50%. Nonetheless, why buy silver in the hope that someday it holds up half as well as gold? Buy more gold instead. (See the bottom of this article for a graph and more details.)
B. Why not to buy gold: this is not one of those articles that encourage average investors to consider holding more than 1/10 or 2/10 of savings in gold, for the following reasons.
- First of all, gold is often market-inverse to a degree beneficial to any portfolio--but can mainly be counted on to "lose less" than the S&P 500 (the average stock market expectation). US Treasuries will more consistently hold steady or go up when the S&P goes down.
- Holding individually-purchased inflation-protected US Treasury TIPS (or perhaps a combination of STPZ, STIP, TDTT, VTIP and TIPX short-term TIPS ETFs) is far safer than gold in terms of miniscule value and custodial risk. There would be no point to holding gold except that someday a war or disaster could force the US government to reschedule its debts.
- The average appreciation for gold over 100 years is more than for US Treasuries but much less than for the S&P. Gold is perhaps the only single investment that is eternally strong. However, as soon as a company is no longer breathing fire, it is no longer in an index. Therefore, in-between global catastrophes, choosing the strongest index ETFs, which in turn choose the strongest companies, is likely to achieve better results than gold and perhaps just as eternally.
- In addition, there are now derivative-based VEQTOR hedging ETFs which, during the 4 out of 5 decades or so that derivatives continue to hold up, will be far more precise, powerful and cost-free than either gold or US Treasuries in hedging stock market downturns.
Gold is gold, but neglecting stocks for gold is like killing geese that lay golden eggs. From 2011 to 2013, as gold lost about -35% while the S&P gained +35%, the all-gold fanatic was hurt badly. However for a more circumspect gold-lover rebalancing between 1/4 gold and 3/4 stocks, the recent fall of gold was one huge buying opportunity. Of course, this combination has the weakness that stocks eventually will fall much harder than gold. Adding individually-bought TIPS and derivative-based VEQTOR ETFs can hedge somewhat against this problem, as well as against each of their own respective weaknesses.
C. Alternatives for gold: this article does not try to suggest how much gold to buy, but only that any decisions about gold should be all about security. Also that the best way to maximize security is through diversity. This might include small--but only small--allocations for platinum and palladium. Gold does not have the highest appreciation potential. However, to repeat myself, the prime directive for monetary metals is security, not appreciation. Silver is volatile because it is not especially scarce. Platinum and palladium might be worth a shot because they might shoot up with increased scarcity and usage--but not during a stock market recession--and they also might shoot down as new energy sources displace catalytic converters. Diamonds or diamond producers (NYSEARCA:GEMS)? Their prices might become made-in-China after the patents for huge good-as-diamond moissanites expire in 2016.
Also, it goes without saying that the traditional emphasis on "sector diversification" has proven rather anachronistic. Every sector, whether industrial or geographic, nosedived in 2008--especially the traditional sector hedge of real estate.
Only physical oil (plastics, chemicals, high performance fuels) might compete with physical gold (money, jewelry, high technology needs) for that magical fusion of scarcity with ubiquity that might guarantee a seldom-weakening value and demand.
Unfortunately, no prominent American seems to see that American oil obviously calls for a rope-a-dope strategy. No Fort Knox gold should be sold away and no North American oil should be drilled away. The future does not depend on who sells the most black gold today, but on who is the "last man standing" with native reserves. In addition--every decade, the value of oil and its extraction safety and extraction efficiency all skyrocket--so what idiot or traitor would want to drill oil now? As an economic force, American oil has only moderate brute strength. However, when combined with America's position as a bastion of global stability, American oil reserves could continually enhance that position if managed with a rope-a-dope strategy. Paradoxically, no prominent conservative, liberal, gold-bug nor economist seems to see this. Gulled on perhaps by oil-driller blurbs and oil-state politicians, every American seems to think the best thing for so-called "energy independence" is to burn up American energy sources. What argument there is seems to focus on tree-huggers vs. SUV-commuters or whether oil production can last 60 years. No prominent American seems to think that perhaps the USA should outlast a tattoo or that perhaps black gold has anything to do with financial security. In keeping with this gullibility, it is a standard practice to be satisfied with contangoed oil derivatives. Consequently--it is possible but rather complicated to invest in oil prices with appropriate levels of expectation vs. volatility.
Consciously or subconsciously, everyone seems to see more clearly about the yellow gold. Consequently--gold loses less value than most anything during a major stock market recession. The problem is how to hold it? Ideally perhaps, hold 1/4 your gold in several different ETFs and 3/4 in close-to-spot gold coins in safety deposit boxes in several different states. Even if you wish to do so however, that makes all the more reason to push a few buttons and buy a few physical gold ETF shares. In a nutshell, gold ETFs offer less security than holding coins but more security than thinking about coins. ETFs also make it easier to rebalance, trend-trade or minimize taxes, as discussed below.
D. Ten good gold and metal ETFs. Including storage locations and approximate annual expense ratios (ER). AGOL has significant bid-ask spread--trade with Limit orders starting at the midpoint, slightly improving your offer every half hour. "Market" orders during standard hours are usually fine for all the rest. My allocation suggestions below de-emphasize AGOL for this reason and also because it uses a relatively less secure island-nation location. Additional alternatives may be available via non-US exchanges--however may complicate tax filing for US residents.
As you probably know: beware of oil ETPs which suffer from contango. Also beware of "ETN's" which do not hold physical metals, thus failing to co-enable the requisite paranoia. Also to repeat myself, forget about investing in silver unless you are proficient in trend-trading or price-hedging.
- Good physically-backed gold ETFs: (NYSEARCA:GLD) by SPDR (London, ER -0.4%), (NYSEARCA:IAU) by iShares (Nova Scotia, Canada, ER -0.3%),(NYSEARCA:AGOL) by ETFS (Singapore, ER -0.4%), (NYSEARCA:SGOL) by ETFS (Switzerland, ER -0.4%).
- Good ETF-like closed-end gold funds: (NYSEMKT:GTU) by CGAL (3 locations in Canada, ER -0.4%), (NYSEARCA:PHYS) by Sprott (Ottawa, Canada, ER -0.4%). Note that my allocation suggestions below give preference to GTU because it has 3 vault locations.
- Good physically-backed platinum and palladium ETFs: (NYSEARCA:PPLT) by ETFS (Switzerland and London, ER -0.6%), (NYSEARCA:PALL) by ETFS (Switzerland and London, ER -0.6%).
- For non-US residents: Swiss ZKB ETFs for gold, platinum and palladium are very good. Apparently however, ZKB is not licensed for US residents. ZKB also may require trading in increments above US$1,000 per share. Rather than go out of your way to use ZKB: buy some gold coins, that's even better (details at the bottom of this article).
- (NYSEARCA:SPPP) by Sprott holds a combination of platinum in Ottawa and palladium in London and Switzerland. Closed-end funds also might have significant tax benefits for US residents. However, this is questionable (details below). Sprott and CGAL also seem to share key executives. Therefore, after considering the following factors, I tend to de-emphasize SPPP. a. Availability of IAU to achieve sufficient Canadian allocations with maximum custodial diversity. b. Desire to increase Swiss allocations via PPLT and PALL. c. Concern for the level-headedness of blokes who create mixed-metal closed-end funds, and in addition, who post multiple tacky websites instead of one good website that could readily resolve the nuisances and ambiguities.
E. Ten basic tips and perspectives about gold.
- To minimize overhead, I suggest a minimum of $1,000 per gold ETF, assuming trading fees are $10 or less. To maximize security, a maximum of $2,000 or 6% of total savings per metal ETF, whichever is greater. For people who consequently only need a few gold ETFs, I would suggest the Swiss-held SGOL and the Canada-held IAU and GTU. Otherwise, for most people wanting to hold $5,000 or more in gold ETFs, I would suggest for each $5,000 of total allocation: $1,000 each to GLD, GTU, IAU, PHYS, SGOL. Or to achieve short-term US tax rates (discussed below) then about $1,250 in each of 4 and leave one unused. Every 2 months, buy-in to the unused ETF after selling-off the next on the list. If investing in PALL or PPLT, you can exchange the both of them for SPPP for two months in the year. However if you want portfolio stability, do not bother with PALL or PPLT, or invest only 1/4 as much as in each gold ETF.
- Put-buying does not affect custodial diversification--but considerations might be more complex for sophisticated Options or Futures traders. As implied at the beginning of this article, a fundamental reason for holding gold is that derivatives might collapse. Therefore, even non-derivative gold cannot be considered gold if held in an account trading in equity derivatives with margin or leverage. Here are my resulting suggestions for derivative investors. a. Consider holding at least half of savings in a non-derivative system at a separate broker. b. Consider that any gold derivatives are not real gold while on the other hand it is still prudent to set a limit to the per-location exposure. c. Consider not using Portfolio Margin. In addition to forcing you to be more prudent, Reg-T Margin forces your broker to close at-risk positions if you fail to do so in a crisis. d. Consider securing the margin with any combination of 5% of account per ETF of non-derivative gold, platinum, palladium and short-term US Treasuries, all marked "liquidate last." Avoid including GLD in this list or any ETF in which you might trade derivatives or any two US Treasury ETFs under the same management. This probably results in the following list: GTU, IAU, PALL, PPLT, PHYS, SGOL, STIP, STPZ, TDTT, VTIP, TIPX, SCHO, FTSD. Keep in mind that if using margin or leverage, this might not count as holding ultra-secure gold or US Treasuries unless the leveraged positions are closed. Nonetheless the theory is that any time you do close at-risk positions, your gold and US Treasury ETFs are immediately much safer than an SIPC cash position. e. If you might have a good strategy for any metal Options, keep quiet about it. Volume is inherently limited. The better your strategy, the more it might be wrecked by popularization.
- Hedging your gold: always a noble endeavor but beware of self-throttling. Primary hedging suggestion: never directly hedge more than half of any long position. Long-term Put-buying means short-selling at a probable cost of at least -5% annually, according to my casual estimates. Short-term Put-buying during the downturns means paying even more outrageous Put premiums. Never buy an "inverse ETF" because daily compounding is decidedly confounding. Trend-trading can do well but is seldom well done and never certain. There are ways around these limitations. For most investors however, rather than directly hedge a position, it is usually more sensible to invest less in that position and more in something else. The best something-else for gold is directly-purchased US Treasury TIPS. The precise hedging of gold also dilutes the primary goal of gold, which is the hedging of stocks. Conversely, the most important hedge for gold is simply to be invested in some stocks. Also as explained above, VEQTOR ETFs are a cost-free way to hedge stocks. (Maximum 2/10 of savings because VEQTOR uses derivatives.) Stock-buying is not a precise hedge for gold. VEQTOR is not a precise hedge for stocks. However the most healthy hedges are never precision-trimmed. The general idea is simply, in the long run, to be earning-while-saving instead of costing-while-saving--i.e. to have two hands reinforcing one another instead of battling it out.
- The populist rumors that GLD is "paper gold" are certainly exaggerated. The most substantive criticism of GLD is that its charter allows it to lease out its gold. I do not like this either. However GLD has never leased and is unlikely to do so. Also, who knows but that the leasing capability might help to keep GLD solvent or to take rapid precautions in the event of an impending war or disaster. I would not place more than 6% of savings in GLD. However I would not place more than 6% of savings in anything that depends on a single physical location. Therefore I think of GLD as one more opportunity for risk differentiation and vive la différence.
- The Titanic actually was the safest boat in the world. The ETF with the highest cons might outlast the ETF with the highest pros. Anyone who obsesses that GLD is unsafe is perhaps depending heavily on some other location and if so perhaps does not understand safety. Diversification is the best way to minimize custodial risk. Therefore by far the most secure physical metal ETF is--using all of them. Just be sure to trade during regular hours with low bid-ask spreads.
- Tips for buying into a Canadian closed-end fund. Compare the fund's 2-year performance to GLD. Also read the "Gold and Resource Report 2010" from Minesite.com. This describes the complications of "premiums" for closed-end Canadian funds, and the Byzantine requirements if attempting to utilize their PFIC status to lower US taxes. CFP Kevin Feldman has stated in a 2012 article about Tax Planning for Gold: "From the comments I've read from IRS officials, it's not at all clear that a QEF election (the process that allows the lower tax rate) would hold up to scrutiny..."
- Currently, ordinary US tax rates might be achieved by selling once a year for five weeks--but don't make assumptions. Primary tax suggestion: gold investors should use a ubiquitous tax preparer such as HR Block, be totally clear and buy "audit insurance" because the IRS is never totally clear. Any physical metal ETF is classified as a "collectible" incurring a long-term tax rate of 28%. For many people it is better to pay the short-term or "ordinary" tax rate. Short-term status can be achieved by selling all physical gold ETFs for 30 days every year. However this weakens the purpose of physical gold as protection against an unexpected stock market downturn. It might be acceptable to invest in 5 out of 6 metal ETFs, and every two months, sell one and immediately buy another. Thus remaining both short-term and continuously invested. You might also deflect taxes with tax-deferred accounts or by using gold shares as charitable donations or as gifts to family members. However, legal interpretations change. Also, the interest on tax debt is non-negotiable and generally ends up much higher than the penalties. So, whatever you decide, please confirm and reconfirm your protocol annually with a tax professional.
- Gold mining and physical silver are two-time losers. Sure, gold mining is a good investment at the right times--but not more so than numerous energetic industries. Sure, gold miners are sitting on arguably the most secure caches of eternal gold--but production profits might or might not increase as the amount that can be produced dwindles. The same goes for oil production. (See the documentary, "What's the Earth Worth?") There are more good silver mines than gold mines, so value investors probably can do well by emphasizing silver mines that were recently upgraded to "buy" by several major analysts. However (as explained near the top of this article) gold mining and silver mining investments both dilute the unique hedging effect of gold vs. S&P, by adding equities that go down with gold as well as with the S&P.
(click to enlarge)
Oil production is different. Oil does not hedge the S&P. Also, we all know what can happen to individual companies such as Exxon or BP. Nonetheless oil does hedge gold. Anyone who loves yellow gold might reasonably focus on the leading non-derivative black gold ETFs: (NYSEARCA:PXE), (NYSEARCA:XOP), (NYSEARCA:XES). However, trend-following is essential to avoid both the industry meltdowns and the possible tapering of production. Or, perhaps don't bother. You can just invest in things like S&P 600 ETFs (NYSEARCA:VBK) and retail industry ETFs (NYSEARCA:XRT) that generally outperform the S&P 500 and do not depend on only one commodity. Other possibilities: VCR (discretionary consumer industries), PKW (companies that self-invest), GURU (companies preferred by hedge funds).
- For extreme security, no ETF can compare to holding close-to-spot gold coins in safety deposit boxes in several states or provinces. If derivatives never collapse, there will not have been much point to buying gold. If derivatives do collapse, the consequences could be so unprecedented that we cannot be totally certain whether, for awhile at least, our online trading accounts might not even function. The only serious problem with coins is that US residents either pay high trading commissions or "collectibles" taxes. This problem might be removed by becoming an occasional dealer, by semi-annually exchanging holdings with close friends, or by holding gold coins only for an amount that you intend never to sell. In any case, as soon as you buy gold ETFs, it makes sense to buy at least as many gold coins as to equal the value held in one gold ETF. Safety deposit boxes are best. In addition to basic safety, you need for your relatives and favorite charities not to be able to get it, but to know where to get it if you slip on the ice. However, inspect annually to avoid accidental account closure. Also read up about "not-so-safe deposit boxes," especially in the event of recessions and natural disasters and molotov mobs. Avoid silver coins and any type of bullion--which are easily counterfeited and therefore uncertain to trade at fair prices, regardless of whether you can prove yours are genuine. Close-to-spot gold coins are easily verified by accurate weighing and measuring, because gold coins are not cost-effective to counterfeit. (However, a few dozen gold or silver bracelets with spot values of US$50 and US$100 can always come in handy for gifts, gratuities, bartering and acquiring aid during a state of emergency.)
- No-fee trading is available for SGOL, PPLT, PALL and SCHO at Schwab.com with a minimum deposit of $1,000. However, most other ETF trades cost $9 at Schwab. Any ETF (including all gold ETFs and the all-important VEQTOR hedging ETFs PHDG and VQT) can be traded for $1 at InteractiveBrokers.com with a $10,000 minimum--or for $7 at MerrillEdge.com with no minimum--or for free at Merrill Edge if you maintain an account value over $50,000. Overall fees can also be lowered--and custodial diversity enhanced--with the following free trading offers for short-term TIPS and high-gain broad-exposure equity ETFs. VTIP, VBK and VCR at Investor.Vanguard.com. STPZ and VBK at TDAmeritrade.com. STIP at Fidelity.com. GURU at Etrade.com. ACH cash transfers are usually free. Account minimums are usually $1,000 and each transfer is usually available for trading in one week. Thus, there are not many free-trading offers for gold, but there are ample offers for high-security US Treasury ETFs and high-performance equity ETFs with which gold is highly synergistic. Anyone with $5,000 or more can maximize performance, diversity and security under extremely low overhead.
Disclosure: The author is long GLD, SGOL, IAU, GTU, PHYS, PPLT, PALL, PXE, XOP, XES, VBK, VCR, XRT, GURU, PKW, PHDG, VQT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I also manage the SN-SOS autotrading system which, as suggested in this article, holds 1/10 of account in gold bullion, 1/10 in short term TIPS ETFs and the remainder mainly in the same hedging and equity ETFs as named. However, all management commissions are donated to charity.