Holding Physical Bullion Really Is Investing

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Includes: DGL, DGLD, DGP, DGZ, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, QGLDX, SGOL, SLV, SPY, UBG, UGL, UGLD
by: Daniel Goldman

Summary

Investing is not trading.

Lower liquidity of physical metals is a positive, not a negative.

There is greater security in physically owning gold and silver.

There are premiums when purchasing physical metals, but they are balanced by not having to pay ETF fees.

Comparing gold and silver to the S&P 500 can help determine how to build it into a portfolio.

Something interesting happened after I wrote "GDX: Canary In The Gold Mine." In the comments, it was claimed that buying physical gold was not investing. This mentality is a bit concerning. Buying precious metals is indeed investing, and it can be a great form of investing.

Investing 010

Investopedia defines investing as "the act of committing money or capital to an endeavor (a business, project, real estate, etc.) with the expectation of obtaining an additional income or profit."

The site also distinguishes between investing and trading, in terms of time scales. "Investments are often held for a period of years, or even decades." If a person is not holding for more than a couple of years, I would say that he is trading, and not investing.

Liquidity

When you buy silver or gold, unlike equities such as (GLD) and (SLV), the reduced liquidity can actually be a benefit. Emotional selling is not something that fits into either investing or trading. It takes time to sell physical bullion, unlike stocks, which are easy to sell impulsively. This improves the chances of sticking with a buy and hold strategy.

Security

Unlike with ETFs, even those backed by physical metal, there is no counter party risk involved in owning physical bullion. It is yours. You hold it in your possession. An ETF, on the other hand, could collapse, and then you lose all of your gold. While it is true that such ETFs are backed by banks, the financial crisis has taught many that banks can fail.

Premiums

Of course, there are some downsides to owning physical metals. Because you are purchasing in smaller quantities, there will be a higher premium. Taking a look at one oz bars, it looks like the approximate premium is about 2.3%. While not trivial, the premium is not horrible, and is partially consumed by the fact that you are not paying an ETF fee.

In fact, assuming approximately 4% growth of gold and (GLD), and a 0.49% fee, which is the current fee for the ETF, in about four years, the physical bullion portfolio would overtake the ETF portfolio.

To keep premiums down, avoid bullion coins, which are sold at a premium because of their potential numismatic value, unless you are of course you are a numismatist. Bars for gold, and junk coins for silver, are probably the cheapest ways to own physical bullion at the moment.

Comparison to S&P 500

It is difficult to determine how gold and silver fit into an investor's larger portfolio, without knowing the actual details of that portfolio. That being said, knowing the beta for gold and silver and the approximate rate of returns can help an investor make an informed decision.

Using monthly data, the approximate beta for London Fix gold prices between April 1968 and and December 2015 was 0.5. Therefore, while gold and the S&P 500, and thus (SPY), tend to move together, gold is less risky. It therefore provides a more stable investment. As for silver, the beta was only 0.07 over the same time period. Because of that, silver allows an investor to drive a portfolio towards zero-beta. This of course assumes that the relationship between silver and the S&P 500 continues to hold.

Comparing ROI during the time period the approximate growth rate for gold was 5.7%, as opposed to 8.0% for the S&P 500. Silver's return was only 3.7% during that time period. However, the ROI of the S&P 500 is skewed higher because of the likely top, or near top, of the current bull market cycle.

Conclusion

Basically, physical metals are not good vehicles for trading. But they are great vehicles for investing. Furthermore, if you want to ensure that your premium for purchasing physical metals is offset by savings from ETF fees, you need to hold for at least four year, although purchasing gold and silver should be a lifetime investment anyway, not something to make a few dollars off of after a few year. Furthermore, gold, while perhaps giving slightly lower ROI than the S&P 500, is far less risky, and therefore desirable as part of a long term investment strategy.

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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I hold physical gold and silver in my portfolio.