Among all the things that people have invested in throughout the years, precious metals have always remained near the top of the list both in terms of popularity and usefulness. Precious metals investing tends to run counter to the movement of other securities, making them a great way to limit one’s overall investment risk exposure, and also tend to hold their value very well in the long run.
Precious metals have been used as financial instruments and as stores of value for thousands of years, most notably gold and silver. Eventually, these metals were minted into coins which were used as money in trade, beginning with the first coins being minted in Lydia, now part of Greece, around 550 BC.
Today, 2,500 years later, gold and silver coins are still used as stores of money, in addition to being held as value in other forms, such as bars. In the 19th century, platinum coins started to emerge, after a history of being added to gold as a means of counterfeiting. As it turned out though, platinum was also valuable in itself as a precious metal, and its value per ounce these days is almost as high as gold.
Precious metals offer the benefit of durability, as they don’t corrode or otherwise deteriorate. Precious metals also have the benefit of portability, especially with coins, and their rarity ensures that the supply will not become saturated and therefore see their price impacted too much.
Even though precious metals continue to be mined, the sheer volume of the supply from the centuries of previous mining ensures that the new supply really doesn’t have much of an impact on prices, and therefore the price of precious metals tends to be driven primarily by demand.
Some of this demand is for industrial use, actually using the metal, in things like industrial processes and especially in the making of jewelry, but a lot of the market for precious metals is driven by those seeking to invest in it.
The precious metals market attracts a wide variety of investors, from central banks who trade in massive quantities, right down to small investors who may buy as little as a quarter ounce.
Historically, precious metals have served as a hedge, and when financial markets are in a decline, people often turn to precious metals, especially gold. There’s no fundamental reason why this is a hedge though, other than the fact that the price of precious metals tend to move in the opposite direction of the stock market from the demand for metals rising during stock market declines.
The word bullion comes from a 17th Century French aristocrat and former minister of finance, Claude de Bullion.
Bullion refers to ingots, or bars, containing gold, silver, or other precious metals that have been purified to a certain standard of purity. The minimum purity to qualify as bullion is 99.5% for gold and 99.9% for silver. Bullion standardizes the creation of precious metals to allow for it to be marketed in a more consistent form, so it can function as a commodity.
Commodities need to be standardized, otherwise buying a certain amount on a market would result in goods of various qualities, and thus complicate the trade and not allow the commodity to be distributed more efficiently.
So in other words, if you had gold of various purities exchanged, a separate market of each level of purity would have to be created, e.g. a market for 90% gold, 91% gold, and so on. Another factor that goes into this is that, generally speaking, if someone is looking to buy an ounce of gold, say, they want to be buying gold and not something else, some sort of alloy.
So what is done is to refine precious metals sold as commodities to as close to 100% as it is reasonably efficient to do so, and you can’t get out all of the impurities, but we can refine it to 99.99% purity without a lot of trouble, and this is the general standard with investment gold.
So when you hear quotes of the spot market for gold as being a certain price per ounce, what is referred to is the price of gold that has been refined to this high standard, and once again, with a commodity we’re looking for a set price on the commodity. Trading commodities in this way also allows for maximum liquidity in the market, the maximum amount of buyers and sellers looking to trade the same thing, in this case gold bullion.
Bullion is traded on the bullion market, which is open 24 hours a day, and mostly consists of electronic trading between purchasers and sellers, referred to as the over the counter or OTC market.
Prices of bullion are referred to as spot prices, the price you pay for the precious metal itself, not including other costs such as commissions, storage costs, and insurance.
The term bullion itself refers to precious metals in ingot form, although there are also bullion coins, which often will sell at a premium to bullion due to their other advantages.
Bullion coins are therefore not bullion per se, and may not meet the purity standards of bullion. The American Eagle gold coin and the South African Krugerrand, for instance, is only 91.7% gold, or 22 karat gold. The Chinese Panda coins are 99.9%, and the Canadian Maple Leaf and the Australian Kangaroo are minted at 99.99%.
Purities are offered as high as 99.999%. Gold coins are legal tender like other coins and do have a face value, such as $50, or $200, but these face values are always far less than the value of the precious metal, and people do not use them as legal tender, although you could in most cases.
Unlike the standardized commodity market of bullion itself, the market for bullion coins is segmented, meaning that there is a separate market for each type of coin, although the coins themselves are standardized. So if you are seeking to buy gold coins for instance, you would need to specify which one you wish to purchase, 1 oz Canadian Gold Maple Leafs for instance.
The value of bullion coins depends almost entirely on the spot price for the precious metal they contain, fluctuating in stride with it. For the most part, the premium cost of gold coins only represents a small percentage of the cost, although rare coins can be valued much higher due to their collector value.
Some people collect certain widely available gold coins as a novelty though, and the preference for coins over ingots does affect the price of coins a little anyway. Gold coins are also more popular in the retail market, for instance you can buy them at banks or at various gold coin dealers, and this retail setting does involve a markup.
So you can expect to pay somewhere around 3-4% more for gold coins on average over the bullion spot price for gold, although buying gold on the spot market does involve other costs, and overall gold coins do not involve paying much more per ounce.
Among the alternative currencies available these days is digital gold currency, which is based upon weight and is a store of value based upon the price of gold without actually needing to purchase gold. This does not really function as currency though very well as merchants do not accept it, but can be a viable option for those who wish to peg their money to the gold market without purchasing it.
There are a number of securities that are tied to the precious metal market in some form, which involve either the security investing in the precious metals itself, in companies that mine precious metals, or some combination of this.
The idea here is that these securities will tend to move to a large degree with the precious metals market, as the spot price of the precious metals involved will either drive the price of the security directly or indirectly. A company mining gold for instance will gain or lose value in step with the spot price of gold for instance.
Securities based upon precious metals do have the advantage of being more liquid than trading in physical metals. If you buy gold, or silver, or platinum, there is a physical good involved which you have to take possession of, it has to be delivered somewhere, sold, and then delivered to the market when sold.
This is the case with all commodities as they all involve physical things, and while securities ultimately involve physical things as well, buying a piece of something, on paper, allows for greater economies of scale as well as much more convenience.
Various gold ETFs and mutual funds are available for purchase, which have all the advantages of mutual funds, where many investors pool their resources to allow for much more efficient trading and securities management. Expense ratios tend to be very low with precious metal funds, and one can enter and exit these funds with ease.
There are even funds that short the precious metal market, for instance if you feel that gold will go down in price you can purchase one of these funds, and all markets have a long and short side, and precious metals are no exception.
Precious metals also offer the ability to purchase derivatives, and since these are commodities they do have a futures market, and the gold futures market is a huge one. One may also purchase options on gold or other precious metals, if one really wants to do some speculation and be rewarded in a much bigger way if one is right, although with greater reward comes greater risk as well of course.
The precious metals market is one of the biggest markets out there, and one that attracts the attention of many investors, particularly those who are looking to balance their positions in other financial markets, such as in equities or the stock market. One can also use this to make money in times where there is a downturn, where downturns in global equity markets generally translate to upturns in the gold market.
Regardless of your intentions, precious metals are definitely worth considering to some extent for many investors, large and small.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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