We live in a busy hurry-up world. Even when it comes to investing, we often seek simpler ways to invest. As for precious metals investment, there are paper alternatives to holding the physical metal, and they appeal to many investors. Also, they appeal to the gambler in us, in that they allow “betting” on the future price of gold and silver. These days of technology, often we never even see or hold the paper that takes the place of the metal, just a computer display of our holdings at our investment custodial website. Let’s look at three ways to “own” gold and silver on paper.
Gold and Silver Futures
You can bet on the future price of gold or silver by buying a futures contract to “control” large quantities of the metal on paper. If the price of the metal reaches or exceeds the level you expected, you have two choices:
- The most commonly exercised choice is to take the cash equivalent of what you gained by guessing right on the metal’s price movement.
- You can exercise your right to take delivery of the metal at the price you originally purchased the option or futures contract.
The problem is that it is well-known that many more ounces of the metals are represented in these option or futures contracts than are being held by the sellers. So, if everyone elected to take physical delivery, there wouldn’t be enough to satisfy demand. It’s good that very few take this option.
When demand and prices on the physical metals are up, it is normal for mining operations to ramp up with the expectation that their profits will ramp up as well. If they do, the value of the company’s stock will rise and provide a nice investment return, but only IF:
- Labor costs do not rise too much.
- Management costs stay under control.
- Operating expenses remain at the same percentage of income.
- Costs to locate more of the metal do not rise.
You’re getting the picture. There is no guaranteed correlation between the value of the physical metal and the value of the company mining it.
ETFs--Exchange Traded Funds
Exchange Traded Funds popped up in America in the ‘90s. With millions of investors for customers, Wall Street entrepreneurs came up with a way to let them invest in the future prices of gold and silver through these funds.
The fund holds some of the physical metal, some mining stocks and some futures contracts. The fund managers decide on the mix, and the investors gain the advantage of affordable fractional investment. While you may not be able to buy a $1,300 ounce of gold every month, you can probably afford to invest $100 in an ETF.
Since the problems of mining stocks and futures contracts were just outlined, your investment in an ETF is only backed by the smaller proportion of actual metal being held physically. Yes, you’ve diversified your risk, but with risky alternatives.
The next time you’re considering investment in gold and silver, think heavier. Go for the real thing, physical metals.