Why I used to like precious metals, but not anymore

I got into saving and investing a part of my income at the beginning of my career. I really like being prudent 🙂 As for a self-directed saver like me my understanding of what’s good for me and my money is evolving. And given my genuine interest in finance this is a direct place to test my ideas. You cannot be expert in something unless you put your knowledge into practice and see what the results you get out of it. I don’t always do this excellently, but I am eager to improve and learn over time.

The last time I wrote a piece about why I don’t buy any stocks. To add some more “saver misery” let me tell you why I used to like precious metals, but now I don’t.

I used to like precious metals since the year 2008. This was a year when I started actively learning about global economy and finance. The economic crisis triggered by sub-prime mortgages in the U.S. sent massive shock waves across the globe and hammered down every stock market on the planet. A particular bloodbath happened on Russian stocks (MICEX index):

And the precious metals market was doing quite robust in this environment. This has ignited my interest in educating myself about economics and finance.

So, what precious metals are all about?

  • Precious metals such as gold and silver are rare and were used as money for quite some time (but not today).
  • Precious metals do not represent someone’s liability. You don’t need anyone to make good on their obligations so your gold bar has any value, it has value on its own because of its properties.
  • Precious metals cannot be directly debased by printing press. The only way to produce precious metals is to find natural deposits and physically mine them. Many people tried alchemy but failed to convert anything of less value into a precious metal.
  • Precious metals do not decay and hold their purchasing power over time (yet it fluctuates thanks to modern monetary system and commodity exchanges).
  • There is a number of efficient ways to own and trade precious metals: bullion denominated bank accounts, ETFs, miner stocks, future contracts, etc. However, be aware that these instruments have counterparty risk associated with them, so your holdings expose you to some third-party liabilities. The only instrument free of any counterparty risk is a metal bullion itself.

I used to own gold and silver since 2008 in form of bullion denominated accounts with a few financially solid Russian banks. There are few features of a such form of bank accounts:

  • Any gains in price of precious metals in your accounts are currently tax free in Russia (can change in future)
  • Bank normally doesn’t charge any holding/storage fee, but normally doesn’t pay you interest
  • You can close your account and sell your gold/silver/platinum/palladium to bank at any time
  • Some banks offer physical bullion withdraw (but it is heavily taxed and stuffed with fees and commissions)
  • Bank makes money on bid-ask spread (like a currency exchange company)

There are some drawbacks though:

  • Bullion denominated accounts are not subject of deposit insurance, so you need to work with most financially solid banks to make sure they don’t go under with your metal
  • Bank might not actually hold any precious metal, but instead hold some derivative contracts linked to precious metal price. As long as you are sure that the bank will not go under, it is fine, but if you are not 100% sure, this can actually mean you can lose it if bank goes bust
  • Precious metal liabilities of a bank cannot be technically transferred to another bank. Neither you can wire transfer precious metals within the country and internationally. If you want a transfer, you have to sell, transfer your money and repurchase the metal from different institution. This has some transaction costs.
  • Cross-border transportation of precious metals in any form is highly scrutinized by governments and sometimes even prohibited.

There is a strong minority in alternative financial experts that advocates for saving in precious metals. And I was quite convinced by them that betting on precious metals appreciation is a good way to protect my savings. I don’t think this is not quite true, but I have changed my tastes over time.

My experience with precious metals as a saving vehicle is somewhat a mixed bag. Gold has done quite well since 2008, but a couple last years precious metal quotes have been under pressure. Whatever I purchased in 2008 gave me a solid profit, but what I added later didn’t perform well. I still believe that purchasing precious metals is a good idea if you choose a right time to do so. Usually you need to wait for a serious correction in price and then buy some more.

When you are in precious metals (PM) you have to understand a few things:

Gold or silver itself is not desirable assets on its own unless we return to metal-backed form of money. Before precious metals are back as money some certain market conditions have to be met for you to make money in PMs. It has to be an inflation disaster and general distrust in other types of assets. Ultimately, precious metals is a type of asset that you hold primarily as an insurance or as a bet on a really nasty economic scenario (that could materialize).

Basically, such negative conditions don’t last very long and don’t materialize very often and this is my problem with precious metals. PM portfolio doesn’t have a cashflow, it doesn’t pay you any dividend and it doesn’t have any expiration time, so planning return on your precious metal holdings is not possible. If things go really bad before you want some of your money back — great, PM prices would be high and you will be able to sell at good price, if things turn temporarily somewhat positive, you might not be able to sell at desirable price.

An ideal saving instrument for me would have these properties:

  • Enough liquidity to get out at almost any time
  • A positive cashflow so you can plan your return
  • A short expiration cycle so your capital is not tied up for a long time
  • Defined risk so you understand how badly things could go
  • Consistent performance that doesn’t rely on particular economic conditions to materialize
  • Governments / central banks should not take huge directional positions in these instruments

Precious metals do not have all of these properties, so I am currently almost completely out of precious metals in order to transfer my savings to Canada.

The next big idea I will be trying with my money in Canada is some certain equity options strategies. I believe I will be able to build such an option structure that will produce desired properties listed above. Stay turned, it is going to be interesting.

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