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A Simple Guide to Investing in Precious Metals

Nov. 1, 2012
Investing, Investments
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By Tyler Arant

Lately, it seems impossible to watch TV or listen to the radio without being berated by a flood of commercials insisting that everyone should be investing in gold and silver.  The main argument seems to go something like this: the value of the U.S. dollar is surely going to plunge, so gold might just be the only thing in your portfolio that has any worth.  It certainly sounds like a reactionary argument, but it leaves many wondering if there’s any validity to it.

The Benefits of Precious Metals

The prices of gold and other precious metals have increased drastically in recent years.  Over the past five years, the price of gold has approximately doubled, and other metals such as silver and platinum have had equally impressive surges in value.  But commodity markets are notoriously volatile, and on any given day jumps in price are as equally as likely as dips.

A main concern for long-term investors is whether precious metals are likely to continue their upward trend in the long run. There are many reasons to be optimistic where the price of gold is concerned.  Whenever the economy is uncertain, demand for gold typically increases.  Investors worried about the future value of the U.S. dollar or the euro have been attracted to precious metals because they provide a safe haven from the chaotic currency markets.

The Federal Reserve recently announced intentions to make major purchases of mortgage-backed securities in an attempt to stimulate financial markets.  This open-ended policy that will flood the economy with more cash has created inflationary concerns among analysts.  Some believe that by investing in precious metals, you could help protect the value of your portfolio from an inflated dollar.  Not to mention, if the Fed pursues expansionary policies for a considerable length of time, then more investors are likely to buy gold, which will lead to the price of gold to increase even further.

Also, central banks have added gold to their reserves to diversify their holdings away from currency whose value could plunge.  China and India are notable examples of this trend.  Everyone knows that China is heavily invested in U.S. debt.  Although many Americans find this troubling, it is also problematic for China.  It is unwise for any investor to be over-invested, and this is exactly the problem China faces.   A drastically weakened dollar would inflict major losses on China’s central bank investments.  So they are attempting to diversify, and gold has played a principle role in this effort.  Last year, China imported 490 tons of gold, analysts believe.

Causes of Concern

One disadvantage to gold is that it does not have many industrial uses outside of dentistry; however, silver and platinum do not suffer from this problem.  Because of its low resistivity, a large amount of silver is used in the production of electronics.  Similarly, platinum is used in a wide variety of goods, including neurosurgical and dental apparatuses, drugs for cancer treatment, and auto catalytic converters, which convert toxic emissions into carbon dioxide and water.

The importance of silver and platinum to industry can be both a blessing and a curse.  One can be fairly confident that in the near to long term there will always be demand for silver and platinum coming from industry.  However, because these metals are so important to industry, there is a risk of them being over-mined. The production of gold, on the other hand, has remained fairly stable over the past decade.

Despite the many reasons to be optimistic, there is still one outstanding reason to be cautious: the dramatic increase in the price of gold may be a bubble.  In 1980, the price of gold collapsed to nearly half its peak value, and silver experienced a similar decline.  It is unclear exactly why this happened.  Right now, it is impossible to say whether a similar collapse in the price of gold and silver will occur as the economy recovers, but there is no guarantee that the price of precious metals will continue to skyrocket.

Ways to Invest

There are several ways to add precious metals to your portfolio.  You can invest in precious-metals ETFs, purchase shares in mining companies, or trade physical bars and coins. Purchasing bars and coins is very appealing to long-term investors that prefer the comfort of investing in physical commodities. Many frequent investors also prefer trading physical units of precious metals, so that they can benefit from small changes in price.

Gold is one of the most popular commodities for an investment strategy known as “spread betting.” The basic idea is to buy low and sell high.  A useful tool for making this type of bet is the spread—the difference between price sellers are asking for (the ask price) and the price that buyers are willing to bid (the bid price).  The spot price is the prevailing current price at which a commodity can be bought or sold.  The spread represents a realistic range of values that the price might take in the near future, and the relation of the current spot price to the bid and ask prices can help investors decide whether the price will increase or decrease as trading continues.

A spread bet is a tax free, leveraged investment, which means that it only requires a marginal initial investment.  Both large gains and losses are possible.  Once you have either taken a long or short position, the break-even price is the price the commodity must achieve in order for you to recover your initial investment. Before you can make a profit, you have to at least make the break-even price AND exceed it by your broker’s commission, account fees, and storage fees.

In many ways, precious metals offer a promising investment opportunity; however, like any investment, there is inherent risk that the shrewd investor should carefully consider.

For additional help getting started in trading metals, check out these brokers.