What you need to know before you buy your first ounce of gold

Some initial guidelines from one of America's top gold experts

Question. What kind of gold should I buy?

Answer. We probably get that question more than any other -- pretty much on a daily basis. The answer, however, is not as straightforward as you might think. What you buy depends upon your goals. We usually answer the "What should I buy?" question with a question of our own: "Why are you interested in buying gold?"

If your goal is simply to capitalize on price movement, then bullion coins will serve your purposes. If you are interested in long-term asset preservation and you have additional concerns about capital and/or monetary controls -- a more complicated scenario -- then you might want to include the lower premium variety of pre-1933 European and American gold coins in the mix. These have been treated by the U.S. government since the 1930s as historical items, and, as a result, afford the privacy-minded investor a greater degree of safety than gold bullion. These can still be acquired at reasonable premiums over their melt value.

But what I just gave you is a rough sketch. To develop a more refined strategy, we recommend spending time with your broker here at USAGOLD-Centennial Precious Metals. We can help you design a portfolio capable of weathering these uncertain times and in keeping with your long-term goals.

Q.When should I buy?

Answer. The short answer is 'When you need it.' You cannot approach gold the way you approach stock or real estate investments. Timing is not the real issue. The first question you need to ask yourself is whether or not you believe you need to own gold. Once you answer that question in the affirmative, there is no point in delaying your actual purchase. The real goal is to diversify so that your overall wealth is not compromised by economic dangers and uncertainties like the kind generated by the 2008 financial crisis.

Q. Can you give us a profile of the typical gold investor?

Answer. Gold owners are a group of people we have come to know very well in our nearly 40 years in the business. Contrary to the less than flattering picture sometimes painted by the mainstream press, the people we have helped become gold owners are among those we rely upon most in our daily lives -- our physicians and dentists, nurses and teachers, plumbers, carpenters and building contractors, business owners, attorneys, engineers and university professors (to name a few.) In other words, gold ownership is pretty much a Main Street endeavor.

Traditionally, wealthy, aristocratic European and Asian families have kept a strong percentage of their assets in gold as a protective factor. That same philosophy has taken hold in the United States in recent years and begun to spread, particularly in light of the on-going financial crisis, and among those interested in retaining family wealth from one generation to the next. In a recent years, we have helped a good many family trusts diversify with gold coins and bullion at the advice of their portfolio managers.

Q. Why not wait for the necessity to arise, then buy gold?

Answer. Over the past few years, as concern about a financial and economic breakdown spread, there were periods of gold coin bottlenecks and actual shortages. The national mints could not keep up with public demand, and the flow of older gold from Europe was stymied by accelerating demand both there and in the United States. Premiums shot-up and a mad scramble developed for the available gold, even at rapidly escalating prices.

These events pointed up some of the problems inherent to the contemporary gold market. During times when demand for gold is booming, you cannot call the warehouse and order gold coins like you can most other consumer items. Even running at full capacity, the manufacturers (the national mints) cannot keep up with demand surges like the one we had in 2008 - 2009. In the case of the older coins coming from Europe, the supply simply dries up because, to make a long story short, they aren't making any more of them. You should not treat a gold acquisition the way you do ordinary consumer purchases. Though your need might be great, the supply might simply have disappeared. If you think you should own gold, the worst thing you can do is get caught up in a price guessing contest as to when is the best time to buy. The better approach is make your acqusition(s) and position yourself positively in the event of further economic problems.

Q. You frequently mention gold as insurance. What do you mean by that?

Answer. Those of you who have read my book, The ABCs of Gold Investing: How to Protect and Build Your Wealth with Gold, know that gold's baseline, essential quality is its role as the only primary asset that is not someone else's liability or responsibility. That separates gold from the majority of capital assets which in fact do rely on another's ability to pay, like bonds and bank savings, or the performance of the management, or some other delimiting factor, as is the case with stocks.

The first chapter of that book ends with this:

"No matter what happens in this country, with the dollar, with the stock and bond markets, the gold owner will find a friend in the yellow metal -- something to rely upon when the chips are down. In gold, investors will find a vehicle to protect their wealth. Gold is bedrock."

This is precisely what people learned during recurring economic crisis situations over the centuries as well as in contemporary meltdowns such as Mexico's in 1994, the Pacific Rim's in 1997, and the United States' slow motion crisis from 2001 to the present. If you consider what investors lost in the U.S. stock market over the last decade and what gold investors gained during the same period, the swing in the net wealth effect is astonishing. When push came to shove, those who owned gold understood what we mean when we say "gold is bedrock." To reduce this to a course of action: Diversification is important.

Q. What percentage of my assets should I invest in gold?

Answer. Once again the answer is not cut and dried, but a general rule of thumb is 10% to 30%, and once again your broker at USAGOLD-Centennial Precious Metals can help you make the decision. How high you go between 10% and 30% depends upon how concerned you are about the current economic, financial and political situation.

Q. In your book, The ABCs of Gold Investing, you start the chapter by saying "Who you do business with is one of the most important aspects of gold investing." Why is that?

Answer. A solid, professional gold firm can go a long way in helping the investor shortcut the learning curve. A good gold firm can help you avoid some the problems and pitfalls encountered along the way, and provide some direction. It is very important to pick the right firm. An experienced and reputable gold broker can help you choose the right gold product mix to hedge your portfolio, make sure the prices you pay are in line with market expectations, and help you in general with the decision making process. Also, the right firm -- one with proven longevity -- will most likely be around to help you liquidate all or part of your holdings should the need arise.

Q. Can you briefly describe what you believe to be the biggest mistake investors make when starting out as gold owners?

Answer. The biggest trap investors fall into is buying a gold investment that bears little or no relationship to his or her objectives. Take safe-haven investors for example. That group makes up 90% of our clientele, and probably a good 75% of the current physical gold market. Most often the safe-haven investor simply wants to add gold coins to his or her portfolio mix, but too often this same investor ends up instead with a leveraged (financed) gold position or a handful of exotic rare coins (often costing five or six figures). These have little to do with safe-haven investing, and most investors would be well served to avoid them -- except as a sideline.

Q. What is your view of gold stocks?

Answer. Many of our clients own gold stocks and we believe they have a place in the portfolio. However, it should be emphasized that gold stocks are not a substitute for real gold ownership, that is, in its physical form as coins and bars. Instead, stocks should be viewed as an addition to the portfolio after one has truly diversified with gold coins and bullion. Gold stocks can actually act opposite the intent of the investor, as some justifiably disgruntled mine company shareholders learned in the recent past when their stocks failed to perform as the price rose. There is no such ambiguity involved in actual gold ownership.

Q. What about gold futures contracts?

Answer. Futures contracts are generally considered one of the most speculative arenas in the investment marketplace. The investor's exposure to the market is leveraged and the moves both up and down are greatly exaggerated. Something like 9 out of 10 investors who enter the futures market come away losers. For someone looking to hedge his or her portfolio against economic and financial risk, this is a poor substitute for owning the metal itself.

Q. Please summarize: What is the best approach for the safe-haven investor?

Answer. If you want to protect yourself against inflation, deflation, stock market weakness and potential currency problems -- in other words, if you want to hedge financial uncertainties, there is only one portfolio item that will serve you in all seasons and under most circumstances -- gold coins and bullion.

Gold Outlook 2011: Irreversible Upward Pressure And The China Effect

In some parts of the world gold is viewed as the protector of wealth. In North America, gold is viewed as a speculative investment. Our economists regard a rising gold price as an admission of defeat, and their disparaging attitude toward higher gold prices took on a more desperate tone in 2010. Nevertheless, gold had another remarkable year, up 25% in 2010, its tenth straight annual gain. Meanwhile, over the same 10-year period, five major currencies – the US and Canadian dollars, the euro, the British pound and the yen – have lost between 70% and 80% of their value. In reality, gold is not rising; currencies are falling in value, and gold can rise as far as currencies can fall. Nick discusses the three dominant medium-term trends that pushed up gold prices in 2010 (central bank buying; movement away from the US dollar; China) as well as three longer-term, irreversible trends that will put upward pressure on the gold price for years to come (the aging population; outsourcing; peak oil). In addition to these trends, more and more investors will be competing to buy a shrinking gold supply. As safe-haven demand accelerates, there will be a transition from the $200-trillion financial asset market to the $3-trillion aboveground gold bullion market. About half of that $3 trillion is held by central banks as reserves; the remainder is privately held, and not for sale at any price. If the world’s pension and hedge funds moved only 5% of their assets into gold, it would trade at over $5,000 per ounce. Nick’s conclusion: Without any new financial crises, both mid- and long-term trends indicate that gold – and silver – will continue rising through 2011 and well beyond.

What Drives the Price of Gold?

Writing for Investopedia, author Jean Folger takes a look at what factors have been driving the price of gold, which is currently trading at record highs.

Central Bank Reserves

Central banks hold paper currencies and gold in reserve. The World Gold Council has stated that central banks have recently become net buyers of gold, the first time this has happened in decades. As the central banks diversify their monetary reserves – away from the paper currencies they’ve accumulated and into gold – the price of gold rises. Many of the world’s nations have reserves that are composed primarily of gold, including the United States, Germany, Italy, France, Portugal, Greece and the Euro area. China has publicly sated that they would like to acquire at least 6000 tonnes of gold

Value of the U.S. Dollar

The price of gold is generally inversely related to the value of the United States dollar: a stronger U.S. dollar tends to keep the price of gold lower and more controlled; a weaker U.S. dollar is likely to drive the price of gold higher. This is because people have a tendency to invest and trade in dollars when the dollar is strong. During times of economic uncertainty and when the dollar is weak, however, people prefer to invest in gold. The massive debt and money printing in the US indicates that further devaluation of the dollar will continue for the foreseable future, thus driving the price of gold higher.

Worldwide Jewelry and Industrial Demand

In 2010, jewelry accounted for approximately 54% percent of gold demand, which totaled 3,812 tonnes, according to the World Gold Council and The London Bullion Market Association. India, China and the United States are the largest consumers of gold for jewelry in terms of volume. Another 12% of demand is attributed to medical and industrial uses for gold, where it is used in the manufacturing of medical devices like stents and precision electronics like GPS units. Gold prices can be affected by the basic theory of supply and demand: as demand for consumer goods such as jewelry and electronics increase, the cost of gold can rise.

Wealth Protection

During times of economic uncertainty, as seen during the recession of the late 2000s, more people turn to investing in gold because of its enduring value. Gold is often considered a “safe haven” for investors during uncertain times. When the expected or actual returns on bonds, equities and real estate fall, the interest in gold investing increases, driving up its price. Gold can be used as a hedge against currency devaluation, inflation or deflation. In addition, gold is viewed as providing protection from political instability, as evidenced by the recent unrest in the Middle East and North Africa (MENA), which may be partly responsible for gold’s recent rally to new highs.

Gold Production

Major players in worldwide gold mining include China, South Africa, the United States, Australia, the Russian Federation and Peru. The world’s gold production affects the price of gold, another example of supply and demand. Gold mine production increased by about three percent in 2010 to about 2,652 tonnes. Despite this small increase, however, gold mine production has been in a decline since the early 2000s. One factor is that all the “easy gold” has already been mined; miners now have to dig deeper to access quality gold reserves. The fact that gold is more challenging to access raises additional problems: the miners are exposed to additional hazards, and the environmental impact is heightened. In short, it costs more to get less gold. These add to the costs of gold mine production, resulting in rising gold prices.

The Bottom Line

We have long been, and will likely continue to be, enamored by gold.  The demand for gold for wealth preservation and portfolio protection, the amount of gold in the central banks’ reserves, the value of the U.S. dollar and the desire to hold gold as a hedge against inflation and currency devaluation, all help drive the price of gold, one of the world’s precious metals.

BMG Bullion President and CEO, Nick Barisheff, recently gave a speech at the Empire Club in Toronto, where he talked about the irreversible upward drivers for gold and his outlook for the market in 2011. To view the transcript of Gold Outlook 2011: Irreversible Upward Pressure And The China Effect .

Gold at Record Highs

Gold may extend its record to as high as $2,500 an ounce in the next year if sovereign debt concerns escalate, Citigroup Inc. said.

The metal climbed to a record $1,921.15 an ounce on Sept. 6 as concerns about debt crises and slowing economic growth boosted demand for a protection of wealth. The metal could “briefly spike” to between $2,000 and $2,500 in the next 12 months and will likely stay above an average $1,200 a year in the long-term, Citigroup predicts.

Bullion is headed for an 11th straight annual gain, the longest winning streak since at least 1920 in London. The metal is up 27 percent this year as investors seek to diversify away from equities and some currencies. Investors’ assets in exchange-traded products climbed to a record 2,216.8 metric tons last month, more than the holdings of all except four central banks, data compiled by Bloomberg show.

“The threat to the global financial structure during the credit crisis has led to high net-worth individuals seeing gold as an insurance against such instability in future,” a team of analysts including London-based Jon Bergtheil wrote today in a report. “This insurance role will likely continue to assist demand while concerns remain about sovereign risk and the longer-term issue of whether the dollar will still be the world’s reserve-currency in 5-10 years time.”

Gold for immediate delivery traded at $1,806.60 an ounce by 10:37 a.m. in London. The metal will average $1,650 next year, the bank said. – Bloomberg

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