The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (31 page)

We have been focusing on gold in this chapter, but much of this discussion applies to silver as well.

Silver is different from gold in that it is a hybrid investment. It is both a precious metal investment and an industrial commodity. About half of silver’s production each year is consumed for industrial purposes, heavily electronics. That means that it is also much more vulnerable to downturns in commodities prices caused by economic downturns. That bodes poorly for silver. However, it is also cheaper and easier for many people to buy and is very much considered a monetary asset. Even our coins were made of silver up until 1965.

So we expect that monetary value to keep silver following gold, but in a severe downturn silver will not track gold as well as it does now, given that industrial demand is still very high.

However, one offset to the downward pressure is that silver is heavily mined as a by-product from other metal mining, most notably copper. In fact, over 70 percent of silver production is as a by-product. So when demand for commodity metals such as copper falls, so will production of silver. This will help offset some of the downward pressure on silver.

The bottom line is that both gold and silver will do very, very well. There may be times when one outperforms the other, but at the height of the Aftershock, gold will be king and silver will be the prince. Regardless of which precious metal you personally prefer, the world thinks of gold as Number One and silver as Number Two (think of the Olympic first- and second-place medals).

Unlike any of the other investments we describe in this book, only gold will do well in all three stages, despite its continued volatility. If you are in it for the longer term, there is really no bad time to buy gold. Buy now, buy later, or buy now
and
later. It is all good. Any price we pay for gold before the Aftershock is going to look like a bargain to us in the Aftershock.

Gold is up almost 500 percent since 2001, and since the financial crisis of 2008, gold almost doubled, although it pulled back in late 2011. The price of gold has been quite volatile, which worries some investors, while others ignore the short-term action and see gold primarily as a good long-term investment.

Going forward, gold will generally continue to do well, but expect considerable volatility to continue. There also is some reason to think there may be a bit of manipulation of the gold price on occasion. Don’t count on gold’s rising more than about 10 percent per year during this time.

As inflation and interest rates rise, expect to see stocks, bond, and real estate values begin or continue to fall. Because gold is not interest rate dependent, rising interest rates will not negatively affect gold. Quite the contrary, investors worldwide will be increasingly attracted to gold in a flight to safety as the interest rate–dependent assets fall. We call this rational fear, and it will push gold up significantly.

To summarize what we already discussed, there are several good reasons why gold will shoot up just before and during the Aftershock:

The bottom line is that there won’t be many investment options as good and easy as gold when the Aftershock hits. The rising gold bubble is your best bet for wealth protection and profits in the Aftershock.

There are many ways to buy gold—some good, some not so good. We think the three best ways to buy gold are:

Many people prefer to buy gold coins rather than larger gold bars. Coins are easier than bars to find a buyer for later when you want to sell. Some of the easiest coins to trade are the Canadian Maple Leaf, the American Eagle, and the South African Krugerrand. Coins are usually one ounce in weight, but often also come in smaller half-ounce and tenth-ounce sizes. You can buy these from local coin shops, but they will be a bit more expensive per ounce than buying online. However, there are no shipping and insurance charges at the coin shop. Some states may charge sales tax or, like Maryland, may require that you buy at least $1,000 worth of gold in order to be tax exempt. You can find local coin shops in the Yellow Pages or online. The U.S. Mint web site (
www.usmint.gov
) also has a searchable database of coin shops based on your location. Getting to know a local coin dealer now may help you later when you want to sell some coins.

Many people prefer to buy bullion online or by phone. Mail-order gold tends to be cheaper because the vendors have lower overhead than a physical store. You can simply type “gold bullion” into the search bar of your favorite Internet search engine and investigate your options, such as
www.Kitco.com
and others. Online outlets and retail stores require certified checks or cash to buy gold, or will ask you to wait until your check clears your bank before they ship or let you pick up your gold.

You can keep physical gold in a safe deposit box at a bank (even a small safe deposit box can hold quite a lot of gold), or in a lockable safe at home, which you can buy at any office supplies store. Eventually, as the various stages of the Aftershock occur, you may have to keep all physical gold at home for maximum safety.

Retail coin stores (online or in your neighborhood) often charge a much higher sales commission or “spread,” often ranging from 3 to 6 percent per ounce. One way to avoid this is to buy gold exchange-traded funds (ETFs), which are traded like stocks on the New York Stock Exchange with the price roughly tracking one-tenth of the price of an ounce of gold, making them a very quick and convenient way to buy and sell gold.

First on the scene in the fall of 2005, gold ETFs now hold more than 1,000 tons of gold. The most popular ETF is GLD and is a product of State Street Global Advisors. Its competitor is IAU and is very similar. A different type of gold ETF is PHYS, which is actually a closed-end fund, rather than strictly an ETF. It holds physical gold in Canada. However, GLD and IAU also hold physical gold. GLD holds its gold in London. They actually list the serial numbers of the 400-ounce gold bars (London Good Delivery Bars) that they hold on their web site.

Gold ETFs have some tax disadvantages and expenses, but their trading convenience and small entry point make them quite popular with investors at every level. ETFs can also be bought on margin. Gold ETFs are safe for now, but could become less safe in the future, at which point owning only physical gold might be best.

An alternative to buying physical gold or gold ETFs is buying gold from a gold depository, such as Monex in Newport Beach, California. With a gold depository, you have ownership of the gold without necessarily taking physical possession, although you can at any time. As soon as you buy it, they sign legal ownership over to you and deposit it with a separate legal entity. If the depository were to go bankrupt, the gold would still be yours.

Gold depositories solve the problems of gold storage and safety, and also give you the opportunity to buy gold on margin (see the section on leveraging gold later in this chapter). As we mentioned earlier, at some point, you may do best to take physical possession of your gold, which is very easy with a depository and not really feasible for most investors with current gold ETFs.

For example, you may first buy gold ETFs because they are easy and convenient. Later, you might sell your gold ETFs and switch to a gold depository because of the ease of leveraging at a higher rate as the gold bubble rises, and because of ease of delivery when you want to take physical possession later. Finally, taking physical possession of your gold may make the most sense if and when the government begins to take adverse actions against gold, such as restrictions on the purchase or sale of gold or very high taxes on gold transactions. Some investors may eventually choose to buy their gold offshore, depending on their circumstances.

Gold mining stocks have the advantage of multiplying the profits that a gold mining company can derive from mining gold. Hence, they can rise faster than the price of gold itself because you receive a multiple of earnings made from selling gold. Revenues rise as the price of gold rises, but operating costs do not. Therefore, as gold prices go up, gold mining companies can do very well.

However, the downside of gold mining stocks is that they can be affected by three key issues that are outside of the price of gold. The first is the overall stock market, which, when it falls, will tend to take everyone down, at least for a while. The second issue is that each gold mining company faces the same company risks that any company can face. Remember, like Mark Twain said, “A gold mine is a hole in the ground owned by a liar.” Third, many mining companies, particularly the larger ones, are not pure gold plays. They often get the majority of their revenues from other metals, such as iron and copper.

While many gold mining stocks will go down temporarily when the stock bubble fully pops, later on many gold mining stocks will do extremely well—in some cases even better than the price of gold itself.

So there is a lot of money to be made in gold mining stocks if you are aware of the risks we just mentioned. Long term, when the stock market falls and gold rises, there will be even better opportunities to buy gold mining stocks. You need sophisticated investment research or competent guidance before going into any gold mining stock. Another option is to purchase a diversified fund or ETF that holds a variety of gold mining stocks, such as the ETF GDX.

By the time the gold bubble is rising rapidly, the stock bubble will have been pretty well deflated so you will be buying gold mining company stock at low prices.

Gold mining stocks may be more attractive if your investment vehicle allows investments in gold mining stocks but not directly in gold. But remember, great care is needed to avoid the downward pressure of a collapsing stock market on gold mining stocks.

One thing we’ve seen in recent years is that leveraging (borrowing money to fund part of the purchase of an investment) can light a fire under the growth of your assets. Hedge funds and private equity funds used leverage to create astounding returns for several years. But that fire can also burn you, as the hedge funds and private equity funds certainly found out.

The same goes for leveraging gold. There is no quicker way to make money on gold, and no quicker way to lose it. The greater the price volatility, the greater the risk, because even if you are right in the long term, you can be squeezed out by margin calls in the short term due to sharp short-term declines in the price. The price may jump back to its high very quickly, but you may have lost much of your money in the dip if you couldn’t make the margin calls on your highly leveraged gold investment and had to sell your position at a low price.

Because we believe there will be greater volatility in the beginning of the gold bubble, we suggest you keep your leverage more limited in the early stages. However, as the gold bubble begins to take off with the dollar bubble pop, you could consider increasing your leverage.

If you decide to buy gold on margin, the amount of margin you can get is controlled by the government, like any brokerage account. But, depending on the volatility of gold, you can leverage three to five times. That means at a 3× leverage you can get $30,000 worth of gold for $10,000 cash. There are also significant interest costs associated with leveraging.

Gold now and in the future will likely be highly volatile, so be careful. We can’t tell you how much leverage to use since the amount of leverage you can take on is very much a factor of your wealth and willingness to take risks. All we can say for sure is that for most people leverage is like alcohol: Use it in moderation.

As much as we like gold, we would never recommend that you put all your eggs in one basket. Without reviewing an individual’s specific financial situation, it is hard to say what percentage they should hold in gold. Many people are comfortable and can handle the volatility of 20 percent in gold, but others may be more comfortable with less and some would be more comfortable with more. The rest of your portfolio requires ongoing active management, as described throughout the book and summarized in Chapter 11.