Wednesday 31 March 2021

Thinking about bullion

I've been watching a few youtube videos with interviews of the likes of Ray Dalio, Harry Dent etc. predicting inflation/hyperinflation and/or stock market crashes/lost decades (no real return) as a result of the monetization of the vast amounts of stimulus spending that has occurred around the globe. If stocks and bonds do poorly as interest rates start to move upwards, and returns on cash remain less than inflation, alternatives such as gold (or silver) might be worth including in one's portfolio as a hedge against inflation.

The problem I have with 'investing' in bullion is that it provides no income or dividends (it actually costs money due to buy/sell spread, fabrication costs, and possibly holding costs and insurance) and while it should provide a hedge against inflation in the long run (as the cost of production sets some sort of floor price, and production costs increase with inflation), the short and intermediate price movements are prone to investor sentiment pushing prices too and high or too low over periods lasting decades. I still remember the remarkable silver bubble that occurred when the Hunt brothers tried to corner the market in 1980.

That said, putting a small fraction of my entire NW into gold or silver may provide some diversification benefit. I thought I already had some gold 1/10th bullion coins lying around that I'd bought from the Perth Mint several years ago. I remember I bought about ten of them and gave a couple away as presents. So I should still have 8 or so -- but I only found one of these tiny, encapsulated gold coins sitting in the box where I keep my silver bullion coins (4 one-ounce coins and one 2-ounce coin). I had already looked in other likely storage places, but so far haven't found them. One of the big problems with keeping physical gold!

So I'm wondering what form of investment in gold bullion (as opposed to gold mining stocks, which are generally correlated with the gold price) I might make. I could order gold coins or bars from Perth Mint and store them, but the production costs mean you pay considerably more than the 'spot price'. For example, 1-ounce gold coins cost 5.0% above spot price, 1-ounce minted bars cost 2.1% premium to the spot price, and cast 1-ounce gold bars cost 1.8% above the spot price. Silver is even worse, with physical coins and bars of 1 to 10 ounces costing around 20-30% above the spot price per ounce!

As an alternative to physical bullion, I could buy a gold CFD. One benefit of that would be leverage, but then again I'd be paying a buy/sell spread and also a daily margin interest cost. Not a great idea for an asset that doesn't produce any income stream.

So, I've decided to open a depository account with Perth Mint. I'll be able to transfer a small amount of money into the account on a regular basis, and then go online to buy either gold or silver at the spot price plus a small fee. I'll probably choose to hold any bullion in the 'unallocated pool' which is backed by physical metal, but in the form of gold or silver sitting in the mint vaults as part of their production process. That way the purchase fee will be 0.5% and there won't be any holding/storage costs. If I ever want to take physical delivery, I'd have to transfer my holding into the 'allocated pool' and then order fabricated bars or bullion coins. I've yet to decide how much money I might regular put into the depository account to make gold purchases with. At the moment the gold price (around $2,200/oz in AUD) has been dropping a bit from its recent peak 9 months or so ago, and is back down to where it started 2020. It could continue to fall back to the $1,600 level it was sitting at during 2017-2019. This is still a lot higher than it was back in 2000, when the price was only $500 an ounce or thereabouts. With inflation around 2.5% during the past twenty years, the price only needed to increase to around $820 to have kept pace with inflation. Then again, the gold price had sat around $500/oz during the 1990s, so it is hard to pick a year that represents a 'reasonable' price for gold. Looking at the inflation adjusted gold price for the past 100 years, it doesn't look particularly 'cheap' at the moment though:

While gold was a good store of wealth during 1929-1935, it was an extremely poor investment between 1935-1970, and between 1980-2000.

Investing a tiny amount in gold is hardly going to have any material effect on the overall performance of my portfolio, and investing a larger amount would be a move from investing towards speculation.

I'll probably just transfer $250/mo into the depository account and buy a regular small quantity to dollar cost average a small bullion holding over several years.

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David Stern said...

I have a gold sovereign I inherited but my real gold investment is in the Perth Mint ETF. The management fee is 0.15% p.a. They take away that many shares each year so that the price exactly tracks the price of gold. I've put 10% of gross assets (not counting our house) into it! My thinking is that if I'm going to use it to diversify I should do it seriously. Of course, with the falling gold price now I'm wondering if that was really a good idea. said...

Yes, dabbling with the tiny amount of Gold I'm game to allocate will have no material diversification benefit or impact on returns. So I'm probably just indulging in this token investment as a psychological security blanket given the uncertainty around inflation and stock/bond performance as I approach retirement. And even as an inflation hedge, gold and silver can underperform for decades at a time, so how it works out is a bit of a lucky dip IMHO. The inflation adjusted gold price plotted over the past 100 years doesn't make the current price look particularly 'cheap', even after the recent pull-back.

While the 0.15% pa admin fee for gold ETFs is modest, I'm not sure that for a long term investment that is supposedly a hedge against inflation it is actually the best option. For instance, if inflation averages 1.5% and gold prices move exactly in line with that over 10-20 years you would be paying 10% of your 'return' in admin fees, so only hedging 90% of the inflationary risk. Of course if we get high inflation like in the 80s and gold prices move sharply higher the 0.15% pa fee will be negligible.

If one puts money into the Perth Mint online depository account via an automatic savings plan the is a 50% discount to the normal 1% transaction fee that applies to bullion trades between $50 (min) and $10,000, and no holding or insurance costs if you opt for the 'unallocated' storage option (ie. backed by physical metal that is used as part of the normal production of the mint).

"A 50% discount is offered on transaction fees in the Online Savings Plan, equating to 0.50% for buying. Transactions are processed using automated pricing against the default currency for the account at the time the Savings Plan transfers are actioned. Savings plan transfers will be actioned on the first working day of each month"

So, over ten years buying via online depository and using unallocated storage would cost 0.5%/10 = 0.05% pa. And over 20 years is reduced to 0.025%, so investing in gold via online depository purchases via ETF is cheaper if held for more than 3-1/3 years. Probably also have to take into account the fee for eventually liquidating, so break-even for online depository account using unallocated storage vs. ETF is probably 6-2/3 years.

There is also the benefit of the Mint depository holdings being guaranteed by the WA State. Not sure what ranking ETFs have in the grand scheme of things (similar to shares?).

"The payment of the cash equivalent of gold due, payable and deliverable by Gold Corporation, the Mint or GoldCorp under this Act and all moneys due and payable by Gold Corporation ... is guaranteed by the Treasurer, in the name and on behalf of the Crown in right of the State."

I'm not sure that investing via the online depository account and using unallocated storage is the 'best' way to invest in gold, but for the amount of my portfolio that will be invested it doesn't really matter.

Paying CGT on any gains when the gold holding are eventually sold means it is probably better to invest in bullion as part of an SMSF investment in retirement phase, than investing outside of super.

David Stern said...

Interesting. I guess I just wanted something convenient to invest in and trade. I think that probably the benefits of gold require rebalancing with other assets as the price does tend to go through waves.