Gold Is No Safe Investment
Maybe you’ve seen the commercials on TV, videos on the Internet, or received something in the mail. They predict economic instability and use graphs of past performance to “prove” gold, silver, or some other precious metal is not only your safest bet but is destined to double or triple in value.
The truth is gold and other precious metals are highly volatile and past performance is not a good predictor of future returns. If sales pitches also include a lot of doom-and-gloom or high-pressure sales tactics, they could be setting you up for fraud.
All that Glitters
Banks and other big investors do buy gold, other precious metals, and commodities like oil, to hedge against inflation and other economic risks. Some investment advisers may even recommend that individual investors put small percentages of their diversified portfolios in precious metals too. But that doesn’t mean that gold or silver or other metals are “safe” places to park your wealth.
Like other commodities, precious metal prices rise as demand goes up, so when economic anxiety or instability is high, the people who typically profit from precious metals are the sellers. Premiums, fees, and commissions can also drain the profit from your purchase. If you are financing your purchase, and not physically receiving the metal, check to see if the seller or firm is registered with the National Futures Association. If they’re not registered, they are likely breaking the law and you should submit a tip to the CFTC right away.
In 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act effectively banned most over-the-counter retail contracts involving gold, silver, and other metals. No commercial entities are allowed to enter into off-exchange commodity transactions using loans or margin. However, the law doesn’t apply to metals transactions that result in physical delivery within 28 days of the purchase.
Firms selling and delivering precious metals to retail customers within 28 days also do not have to be registered with securities regulators.
For example, from a recent case, the CFTC ordered an individual and his firm, Southern Trust Metals, Inc., to pay more than $2.5 million in restitution because they claimed to purchase physical precious metals that were allegedly held in depositories in London or Hong Kong. It was reported that customers were told they could purchase additional metals with loans offered by the company. In reality, no metals were purchased or sold and the defendants didn’t provide any loans. Instead, they transferred customer funds to engage in margined derivatives trading. These practices are illegal but are not uncommon.
There are several ways you can buy and sell precious metals. You can buy bullion or coins from a bank or other dealer. You will pay the spot price plus a markup or “premium.” You’ll want to compare premiums from multiple sellers to make sure you’re getting the best price. For you to make a profit, the spot price would need to increase enough to cover the premium plus any other costs associated with selling the metal. You can learn more about what to consider when buying coins and bullion at the Federal Trade Commission’s website.
Hedgers and speculators also buy precious metals on the futures markets. Hedgers use the markets to lock in future delivery prices. Speculators try to make money on trades and add liquidity to market.
You buy futures contracts using margin, which means you can control a large contract position with a relatively small amount of cash. For example, gold trades in 100 ounce contracts. If you want to buy a December gold contract worth $132,170 ($1321.70/ounce x 100 ounces) you would need to maintain a margin value of $5,400. This amount of leverage could mean big profits if the price of gold goes up, but it could wipe you out if prices drop. Here’s why: For every $1 the price drops, you would lose $100. That money comes out of your margin account and must be replaced. The spot price would only have to fall about 4 percent to wipe out your initial $5,400 investment.
Precious metals prices are predominantly determined by supply and demand, but can also be impacted by other external influences. These can include inflation expectations, the strength of the dollar to other currencies, geopolitical events, and related commodity market activity such as the price of other precious metals or other commodity prices. Also, there are often substantial fees associated with opening and maintaining an account. These do not include commissions, which could reach upwards of 15 percent on the leveraged amount. Costs can add up quickly.
- Be very suspicious of unsolicited calls and demands to act now. No reputable firm or broker would need to deploy high pressure tactics. In fact, if you receive a cold-call, just hang up.
- Be wary of offers made on television, radio or on the Internet, especially if they use a name that sounds like an official government agency.
- Be suspicious of claims of big returns for very little risks, or that offer guarantees or agreements that limit your losses.
- Watch out for offers that require you to only pay a small percentage of the total purchase price, or that allow you to pay with a loan financed by the company.
- Beware of claims that the metal you purchase will be stored for you in a bank or other facility.