Ways to Invest in Precious Metals
The two main methods for precious metal ownership hinge on one key characteristic -- whether you, the investor actually physically posseses the metals, or whether a 3rd-party, such as a bank, possesses the metal. Here we will outline the most common methods of precious metals ownership.
Option One: Buying and Owning Physical Precious Metals
There is no substitute for actually owning physical precious metals. You purchase the metal and you then take delivery of the metal. You possess the metal and you gain all the benefits from physically owning a valuable commodity. There are no middlemen who are taking a cut and if you need the metal it is already in your possession. The non-physical methods of “owning” precious metals often involve a 3rd party taking a cut of your investment, plus, you do not actually possess the product you have purchased.
Option Two: 3rd-Party Methods for Buying Precious Metals
There are a large number of ways that investors can buy bullion and use 3rd-parties to hold the actual metal. Below are outlined the most common methods.
Precious Metals Certificates
Investors can buy precious metal certificates from any number of banks. The certificate states that the investors owns a specific quantity of silver or gold, held by the bank on the investor’s behalf. Generally, three types of accounts are used when investing in Precious Metals Certificates: allocated accounts, pool allocated accounts, and pool unallocated accounts.
The allocated account option provides the investor with a certificate indicating that specific bullion bars or bullion coins are held by the bank, on behalf of the investor. The investor has to pay an upfront certificate fee, as well as ongoing fees for storage of the physical precious metals.
The pool allocated account works differently. The certificate indicates that the investor does, indeed, own a specific amount of precious metal but that metal is pooled with that of other investors and is not in any specific form. Again, the investor must pay an upfront certificate fee, along with ongoing fees for storage costs.
The third option, a pool unallocated account, is similar to a pool allocated account, but the bank (or other holding institution) is allowed to use the precious metal for their own needs. Allocated accounts do not allow the institutions to use the stored metals in any way, but unallocated accounts allow this. Typically unallocated accounts do not have storage fees, making them less expensive, but clearly they are riskier as the bank may not have the metals on hand should you want to receive them.
Precious metals certificates are reasonable investment options for investors who want to buy gold, silver, and platinum, but do not have the means to store precious metals securely. Beyond this advantage, there is little reason to buy precious metals certificates as you simply end up paying fees for somebody else to hold your precious metal for you. Precious metals certificates are also expensive -- a $10,000 minimum is commonly seen.
Precious Metals Futures Contracts
Agreements between two parties for future deliveries of precious metals at a specific price are known as Precious Metals Futures Contracts. Buyers of precious metals futures contract agree to buy some set quantity of precious metal at a future date. Sellers of futures contracts agree to deliver this set amount of precious metal at the specified date. In the United States, precious metals futures contracts are almost always traded on the New York Commodities Exchange, or COMEX. COMEX sets standard contract settlement dates and contract agreements governing precious metals futures contracts.
With these futures contracts, actual physical delivery of precious metal hardly ever occurs. Traders usually cancel out their positions before the actual settlement date -- they are merely trading cash positions based on movements in the price of metal, they are not trading physical metal itself.
To place a precious metals futures contract, both buyer and seller must pay a margin, similar to a down payment. In the US, COMEX determines the margin requirements, which are based on precious metal market volatility. With a futures contract, margin requirements are significantly less than the actual value of gold, silver, or platinum in the contract itself. This means that investors can leverage their capital into much larger amounts of metal than they would be able to physically purchase.
This is the one big advantage of futures contracts -- investors can often leverage several times the margin requirements, enabling them to buy gold and silver in large quantities for a fraction of the upfront cost. This fact can come back to bite, however. If the gold spot price were to suddenly drop a few percent, those losses come directly out of the initial margin requirement, meaning an investor can lose most of the initial capital even if the market dips slightly.
The same disadvantages that Precious Metals Certificates have are also true here. Namely, the investor does not own the physical precious metal itself. The largest advantage of investing in gold and silver bullion is the ability to own the physical metal itself. Investments like Futures Contracts negate this powerful advantage.
Exchange-Traded Funds (ETFs)
Exchange-Traded Funds are trusts that hold physical precious metal. Investors are able to buy shares in the trust, and the price of these shares is directly tied to the spot price of gold, silver, or whatever precious metals the trust may hold. The trust deducts expenses for storage and overhead costs. ETFs, like Precious Metals Certificates, allow investors to buy gold and silver bullion without having to secure and store the metal.
That being said, when buying shares in an ETF, investors do not actually own any physical metal, nor can they exchange their shares for physical delivery of metal. They merely own shares in a trust. ETFs are less advantageous than actually owning physical precious metal -- not only does the individual investor not own the actual metal, they have to pay ongoing fees associated with the trust. If a crisis hit, a ETF buyer would be left holding nothing but a piece of paper.
Stocks in Mining Companies
This option of investing in precious metals is only loosely-correlated with the metals themselves. Investors occasionally will buy stocks in the companies that mine, refine, or recycle precious metals. The stock price of these companies tends to rise when the spot prices of precious metals rises. That correlation is not 100%, however. Many factors are involved with the stock price of an individual company, and even gold mining firms have a myriad of factors which influence stock price.
Again, the main benefit of buying stock in mining companies versus buying physical precious metals is avoiding the problem of securing and storing the metal. Like the other examples highlighted above, in this case the investor still does not actually own any physical precious metal. Not only that, but the stock price in these types of companies can rise or fall independently of what metal spot prices are doing.
As seen, there are two different types of precious metals ownership. With one option, under which fall several different methods of investing in metals, the buyer does not actually take physical possession of the metal. The other method, buying physical precious metals and taking actual delivery of them, has strong advantages over the other methods. Buying precious metals bullion gives the investor full control over the products that are purchased, when they are purchased, and because they are present on-hand, the choice of when and how to sell bullion, if needed. In the next section, we will examine the different types of precious metal bullion available to investors who choose to buy physical bullion.