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Saturday, August 18, 2007

Gold Bullion Investments: Which to Buy, Gold Coins or Gold Bars?

By Michael B. Clark

Precious metals have been one of the top performing asset classes over the past six years, and investors wanting to add a precious metals component to their portfolios are often overwhelmed by the number of investment vehicles available to them today. Alternatives include precious metals futures and options contracts, government certificates, “digital gold,” exchange traded funds (ETFs), mutual funds, mining shares, as well as buying the physical bullion itself. All enable an investor to gain exposure to the precious metals markets and participate in what many investment experts foresee as a continuing multi-year secular market.

Having exposure to gold, in particular, the world’s pre-eminent tangible asset, either through a direct purchase of the physical asset itself, or by adding one of the other aforementioned alternative vehicles, is highly recommended in today’s environment.

But to be sure, there is no “holy grail” of gold investing; it should never be an "either / or" scenario. Just as prudent investors hold a range of investment types to minimize their dependence on a single asset class in their overall portfolios, investors should also consider further diversifying their holdings by acquiring a number of these precious metals vehicles within this particular component of their portfolios.

As an example, a smart, holistically diversified investor might hold a combination of physical gold in his/her personal possession, government certificates and physical gold in an allocated account, and “digital gold,” along with some exposure to the mining sector via equities.

But, each of these vehicles is unique and can be complex. Thus, investing in them requires a thorough understanding of not only their various advantages and potential rewards, but of their relative risks and individual disadvantages, as well. Therefore, an investor should carefully study, and perform proper due diligence on all aspects of a contemplated gold investment. Credit risk associated with the company selling the investment, the company (or companies) behind the offering, and the custodian holding it, if applicable, should be of paramount concern in the investor’s mind, as a sound credit rating of these entities is as important as their business history and professional experience.

Ultimately, the crux of the answer as to which to buy rests with the investment objectives and risk tolerance of the investor. Indeed, there is no single, correct answer for every investor, and seeking the assistance of a reputable, trusted investment expert is the best approach for most investors when contemplating making a gold or other precious metals investment.

But for many investors, perhaps the simplest and most straight forward way to gain exposure to the precious metals markets, and eliminate many of the uncertainties and/or complexities associated with the alternatives, is to own physical precious metals outright, by buying gold, silver, or platinum in the form of Bullion Coins or Bullion Bars.

But first, why would an investor want buy physical precious metal commodities to begin with? Good question…

As a physical asset, bullion is inherently valuable. This is to say, physical precious metals have tangible, intrinsic and innate value in and of themselves, and they are, therefore, the only asset class that is not some outside entity’s or third party’s liability (as is the case with a stock or bond). Thus, the investor who owns the physical asset directly, and whether held in his/her personal custody or stored safely in his/her name in an insured account at a qualified facility, will enjoy the sense of security one derives from knowing that their investment portfolio is strengthened by the presence of an actual tangible asset with an intrinsic value, and not just a piece of paper, or derivative product, that serves as a proxy for precious metal.

In contrast, “paper precious metal” investments present considerably different risk-reward considerations. For example, buying shares in a mining company provides ownership in an entity that produces gold or silver, but not direct ownership of the commodities themselves. Management and accounting competence, environmental risks, hedge book exposure, potential political turmoil, and a host of other vital considerations need to be taken into account when deciding to buy shares of a mining company to add to one’s portfolio.

On the other hand, precious metals futures and options are legal contracts that can leverage one’s gains, but they can be complicated investments and they can exacerbate one’s losses.

Exchange Traded Funds (ETFs) are derivative vehicles that track the price of gold and silver. Two of the more popular are the New York-traded streetTracks Gold Shares (NYSE:GLD) and the London-traded Lyxor Gold Bullion Securities (LSE:GBS). As derivative products, they do not provide their owners with title to the underlying asset, as one has when holding gold in an allocated account or in one’s personal custody. Thus, ETFs are often used by day traders, hedge funds and institutional players speculating on short term movements in the gold price.

From the investor’s perspective, although the price of a gold ETF will move in tandem with the price movements of gold, owning an ETF is not the same as owning gold directly. In fact, owning an ETF may defeat the very purpose many investors buy gold as a physical, inherently valuable asset (and tangible currency) to begin with. For many investors, the primary reason to own gold is that it is the ultimate safe haven physical asset to have in times of economic or geopolitical uncertainty. ETFs, on the other hand, are a form of debenture.

Thus, should an ETF provider go into liquidation, its investors will become general creditors of that provider, since ETF assets are not held as allocated assets, titled in the individual names of the investors. Direct ownership of gold bullion, on the other hand, either by holding it in one’s personal custody or having it stored it in a physically allocated account (and off the custodian’s balance sheet), and titled in the owner’s name, insulates the investor from the potential losses experienced by general creditors in bankruptcy scenarios.

In other words, owning the physical precious metal directly removes most of these ancillary, but critically important considerations.

So, once a decision has been made to invest in physical bullion, bars and coins are the choices available. But, which does one buy? Let’s review their respective characteristics.

Bullion coins are highly refined precious metal products that are round in shape (as opposed the rectangular shape of a bullion bar), and produced to exacting specifications by numerous federal governments throughout the world, specifically for investment purposes. These coins are produced in large quantities and come in a variety of sizes, which are convenient to own and trade -- typically one, one-half, one-quarter, and one-tenth troy ounces. Their content – that is, the weight and purity of precious metal they contain -- is guaranteed by the governments that produce them.

The United States Mint describes a bullion coin as: “a coin that is valued by its weight in a specific precious metal. Unlike commemorative or numismatic coins valued by limited mintage, rarity, condition and age, bullion coins are purchased by investors seeking a simple and tangible means to own and invest in the gold, silver, and platinum markets.”

Moreover, while bullion coins are ascribed legal tender status in their country of origin, they are actually valued by the market for their precious metals content, plus a small premium representing the cost of production, shipping handling and the seller’s profit added to their price. They are readily bought and sold by investors through a world-wide network of precious metals retailers, wholesalers, banks and brokerage firms. The current prices for most major bullion coins are published daily both on the internet and in financial publications such as the Wall Street Journal, internationally. Thus, bullion coins are an excellent choice for most investors.

Bullion bars, on the other hand, are rectangular blocks of investment grade precious metal (also referred to as “ingots”) manufactured by commercial refiners. (Note: the most reputable and prominent commercial refiners have standing with, and are recognized by the world’s leading precious metals exchanges.) Bullion bars are produced in a wide range of sizes – from 1 gram (or less) to 400 troy ounces (or more). They typically bear four distinguishing marks that uniquely identify them, including their refiner’s mark (i.e., the bar’s brand name), the gross weight (usually in troy ounces), the metal fineness (or “purity”), and the bar’s serial number.

Having been produced commercially, they have no legal tender status, but reputable refiners stand behind the quality and authenticity of the bars that bear their brand name. Both small and large sized bars are also highly liquid and easily traded worldwide, provided the larger bars are not held by the investor personally (more about this point appears below). And, like bullion coins, the price of these bars varies with the market value of the precious metals they contain, plus a modest premium representing the cost of production, shipping, handling and the seller’s profit.

An important distinction between coins and bars that a precious metals investor should understand is that, while bullion coins produced by mints and small “investor bars” produced by refiners are specifically designed to contain an exact weight of the metal they contain (e. g., exactly one-ounce or one-half-ounce of platinum), larger sized bullion bars (e.g., 400-ounce gold bars or 1000-ounce silver bars) are not. To keep production costs down and their associated premiums to a minimum, large bar weights and metal purities are maintained within internationally acceptable ranges. (Example: a so-called “400 ounce” gold bar may actually weigh 404.360 troy ounces and have a pure gold content of 99.65 %. By multiplying the bar’s gross weight and the fineness together, the investor can calculate the exact amount of pure gold the bar contains -- 402.944 troy ounces, in this example.) While this manufacturing method keeps the premiums paid for these large bars low, thereby allowing the buyer to get more precious metal in his/her investment, it requires the owner to use fractions to calculate the bar’s absolute metal content. This may prove a confusing and inconvenient requirement for some investors; thus, large bars are usually traded among large companies and sophisticated investors.

There are, in reality, three important aspects for an investor to consider when choosing between bullion coins or bullion bars for investment. Each of these aspects can affect the cost of the investment and affect the flexibility the investor has over his/her investment. These considerations include the following:

1) Premium – as discussed above, this refers to amount of money an investor is charged for the product over and above the value of the metal the coin or bar actually contains. As stated earlier, the premium represents the cost of production, shipping, handling and the seller’s profit. A higher premium is normally paid for smaller-sized coins and investment bars (i.e., 5% - 20% depending on size) than is paid for large investment grade bullion bars (i.e., 2%- 5%). This is because, like with most products, it costs the manufacturer – in this case, a mint or refiner – more money to make, say, 400 one-ounce perfectly shaped, designed and inscripted pure gold coins, than it does for that mint or refiner to produce the single inexact weight and pure “400-ounce” gold bar described above.

2) Custody -- An investor may desire to hold his/her bullion coins or bars close at hand and, therefore, may request personal delivery. This is fine for bullion coins and small investment bars, as neither will typically require assay (unless they are materially damaged) at the time they are ultimately sold. But, because the content of large bars can be manipulated or altered in ways that are difficult to detect by visual examination, even by seasoned professionals, a time-consuming and costly assay will be required if the investor has taken personal possession of them and presents them to a dealer for sale. Thus, investors who buy large bars for their portfolios are advised to leave them in storage (in an insured account titled in their name) at a reputable recognized precious metals depository. If a large bar is kept in such a storage facility, its liquidity will not be affected at the time of sale.

3) Flexibility – Does the investor intend to just buy, hold and then ultimately sell his/her precious metals for profit? If so, then perhaps buying bullion bars may be best, as the premiums paid at the time of purchase will be lower. Or, is this a long-term investment that may be a permanent part of one’s estate that will be passed on to a number of heirs? If this is the case, then buying bullion coins may be preferred. One thousand one-ounce bullion coins can be readily distributed among five heirs, where as two 400-ounce and two 100-ounce bullion bars cannot.

To summarize, an investor should carefully consider his or her investment objectives, the amount of money he or she plans to invest, their need for liquidity, and the current geopolitical, macroeconomic and systemic risk when making an investment in precious metals. And while the variety of bullion products may seem somewhat overwhelming, the "best" product, in all likelihood, will differ for each investor. However, it is the abundance of investment products available in the marketplace that allows investors to tailor their portfolios to meet their particular needs.

Consultation with a trusted precious metals advisor can help the investor determine the best precious metals products to satisfy their individual risk tolerance and specific investment objectives.

Michael B. Clark is a consultant to Gold and Silver Investments Limited, www.goldandsilverinvestments.com , Ireland's Asset Diversification and Wealth Preservation Specialist. He is the President of Solidus Associates, LLC of Wilmington, Delaware, and has served in the precious metals industry for 25 years. He oversaw Deak-Perera's Precious Metals Certificate Program, America's largest precious metals investment program, in the early 1980s. Later he became Vice President of Precious Metals at Wilmington Trust Company, and President of both Delaware Depository Service Company and First State Depository Company. He obtained licenses for Wilmington Trust and DDSC to operate as Nymex and Comex depositories.