Why You Should Buy Gold

| About: ETFS Physical (PALL)


Soliciting investment related questions from readers I received many great ones.

This one being about taxes and goldbugs.

Is it good or bad to hold gold?

I am a big believer in tax efficient savings. But, how do you prepare for regular RMD coming out of your account. It seems that, once you hit 70.5, your RMD size is going to be greater than cash accumulated from dividend yield or REIT distribution. So, you are forced into selling the portfolio down. Is there a way to change the RMD calculation by either lengthening the calculated years or clever year end manipulation of the portfolio? Also, I hear that you can call the RMD earned income so the after tax portion can go into a roth. Is that true?

The second is the emotional discussion of people who are so angry or scared of the market that they pulled out and put it all in gold (or diversified into gold and silver...) These folks are not logical. I hate when they enter the room smug in the knowledge that they are prepared for the next Armageddon when in fact they are making a huge mistake.

Even if Armageddon was coming, the grocery store does not take gold and you must convert it to dollars or watch it lay uselessly in your back yard. Better to buy a gun and a peppers station under your house.

The first question by this reader, I'll keep his name confidential as it involves a tax question, is a little bit too tough for me. I understand this is about a required minimum distribution, but I'm not a U.S. citizen and lack any knowledge of this subject.

The second question is about goldbugs. They sure can be annoying and the way they are now is nothing compared to when the next crisis hits.

I'm not sure they aren't thinking logical. Certainly, they are operating under a different paradigm where their actions do make sense.

To an extent, I understand it if someone tries to live a decent life on his or her income and put all savings into gold; with the expectation of keeping up with inflation in even the worst case scenario and making bank in a few worst case scenario's like a zombie apocalypse or raging inflation. Actually, I prefer that strategy to putting all your savings into a savings account, a popular investment plan in the Netherlands, non-existent interest rates notwithstanding.

Any strategy where anyone puts nearly 100% of their assets into one type of asset doesn't make a lot of sense to me. It must be the result of laziness, overconfidence or lack of imagination.

A friend of mine recently spent some time working as a gardener for a small business. The small business owner turned out to be one of those gold bugs. What surprises me most is how open these guys are about their preference. Telling everyone how much you love physical gold as an investment, kind of defeats its purpose.

Even if you don't get robbed, it doesn't necessarily work so well as a safe haven as it isn't entirely clear you will be able to access your stash when the Black Swan event manifests itself. A famous example of a gold stash not providing the desired protection is the Hoxne hoard as the owners clearly were never able to retrieve it.

So there is something to be said for, as this reader suggests, investing in a gun instead. People have, mostly tongue in cheek, given the appropriate preparations for catastrophic events a lot of thought. Even the CDC has a list of stuff that's useful in the event of the zombie apocalypse.


Source: CDC disaster kits

It doesn't include a gun but there are much more elaborate survivalist lists of useful gear and suggested supplies. The risk that it will be useful at all in your lifetime is small (depending quite a bit on where you live). However, the value of these items the moment you need them, is nearly infinite. I'd never suggest starting an investment career by stocking up on survivalist items, but if the total cost of disaster preparation is negligible and the payoff at the time you need it is nearly infinite, it should be a reasonable investment at least.

I took this detour because gold benefits somewhat from the same type of optionality. In history, it didn't always do great during times of hyperinflation (like Brazil 1980) but according to this CFA paper, its expected value is very sensitive to hyperinflation once the odds of experiencing hyperinflation are one in a billion or less:

By the time I reach a one-in-a billion chance of hyperinflation, the expected value of gold is $72,970. So, I conclude that even a small probability of hyperinflation has a big impact on the price of gold.

Goldbugs could even be right and the expected value of holding a portfolio of gold far exceeded the expected value of a portfolio of stocks. For example, if the odds of hyperinflation are far greater than one in a billion. At the same time, it's very possible the far most common outcome will be for them to underperform badly. Truth is, they could be right but there is no way to know for sure.

Ultimately, Campbell R. Harvey recommends holding some gold, in his paper, but as part of a broader basket of commodities. That's a solution that's fairly elegant. In the scenario where gold value goes up 100x, even a small allocation will achieve preservation of your ability to buy stuff but in the vast majority of futures where gold goes down or does nothing, you are hardly held back by it.

Holding commodity ETFs is a great way to see your money evaporate as you are facing roll costs of the underlying future contracts. Unless the Black Swan hurries, your hedge is gone before it ever hits. It probably works better to hold physical commodities. I don't really like anything that goes bad (like agricultural commodities) because you want to have it in set and forget mode.

Some of the precious metals are fairly easy to stash but if you diversify into more common metals, your spouse isn't going to like it. Or, alternatively, you are faced with a lot of warehousing expenses. There are quite a few commodity-backed ETFs though. Meaning they are holding the physical commodity at scale which is more efficient as compared to you stashing it in your basement. According to ETFDB.com, the following ETFs are all physically backed options: SPDR Gold Shares ETF (NYSEARCA:GLD), Physical Silver Shares ETF (NYSEARCA:SIVR) and the Physical Platinum Shares ETF (NYSEARCA:PALL) and Physical White Metal Basket Shares ETF (NYSEARCA:WITE).

Make sure to check my previous article in this series where I answer questions from readers called: How I Approach Position Sizing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.