Jon Nadler: How to Hold Gold
Jon Nadler: How to Hold Gold
Source: The Gold Report 10/24/2008
In this second installment of The Gold Report’s exclusive interview with Kitco senior investment products analyst Jon Nadler, he not only shares a few insights about the so-called “poor man’s gold” (silver) but offers specific advice about how much of the real McCoy our portfolios should hold. He also sheds some light on the differences among EFTs, gold funds and pool accounts.
TGR: About a year ago, you told us that between 8% and 12% is an ample amount of gold to hold in the portfolio as insurance. Do you still advocate that sort of allocation?
JN: Given the circumstances we face now, I wouldn’t be uncomfortable raising that by 2 or 3 percentage points on both ends, so 10% to 15%. At the height of the crises in the ’79 to’81 period, some of the Swiss money managers that I recall following had recommended upwards of 25% in gold. There were valid reasons—double-digit interest rates and double-digit inflation and other scenarios unfolding that were truly pretty catastrophic. But I’ve not seen it higher than that.
I’ve seen it as low as 3% to 5% in the good times in the ’90s. Biotech, high tech, everything was roaring ahead; real estate was great and there was little need for the insurance. It was probably a little too optimistic to reduce it to those minimum levels. In general, right around 8% to 12% is still okay. I think 10% is a very good target.
TGR: Now that we’ve looked at how we may want to put some of this into our portfolios, can you give us your thoughts about physical gold compared to gold ETFs and funds such as the CEF and James Turk’s GoldMoney?
JN: When you get into the fund situation, CEF (which actually I like better than the ETF) would be intermediation. The ownership structure we like better than what we see in the GLD itself. Actually, James’ construct is a digital gold account, same as the Kitco pool accounts, but with a few additional features. And GoldMoney has done quite well, as their balances have grown impressively.
I remember when I first consulted with James, he had maybe $50 million or $60 million and they’re approaching $400 million or so now, reflecting the markets we’ve seen in the last several years. Kitco has its regular pool account, and another one that is a version built in collaboration with the Royal Canadian Mint. Essentially, all three are forms of physical gold ownership held in custody on behalf of the investor. Access to the accounts, generally, is an online interface as opposed to carrying around paper certificates such as the Perth Mint Certificate product, which is another excellent version of gold or silver in safe storage.
TGR: Tell us about your Royal Canadian Mint pool account.
JN: It’s basically like the “regular” pool account, only storage thereof is limited to the RCM’s Ottawa facility, so it’s a government-owned vault and the product in storage is limited to RCM-produced products such as the bars and coins they make. Nothing from the outside with questionable hallmarks can come in. The beauty of this product is that clients who own these ounces of gold or silver can log in directly into the Mint’s website (they are given individual usernames and passwords known only to them and the Mint) to audit their own holdings day or night.Any movement of metal that they may have sold, orders for such movement, must come from the client directly and only to the depository. It’s an extra measure of safety and, for the money; it’s very worthwhile. It costs the investor a flat $60 a year to have that account maintained and insured and segregated in that respect.
TGR: What reservations do you have about ETFs?
JN: Basically the trustee holds the gold, so you already have a party you need to trust; ergo, the named trustee. You have attrition of balances due to management fees, which could move higher any time. It’s a question of cost. Right now it’s only 40 or 50 basis points, but likely it will eventually rise closer to 1% or so. And then there are questions. Do you want to be trading like a stock subject to general stock market volatility or holidays or rules or reporting requirements? Or do you want to be trading more in the sense of an open gold market with ownership of fractional ounces?
The big difference between the ETF and the others is your ability to convert into usable, fabricated product. That’s simply something you cannot do with the ETF. All of these other vehicles let you convert into coins, bars, and so on for a small premium. That is something you saved up front, but you can definitely take possession of your holdings. For instance, Kitco pool and GoldMoney permit the holder to receive balances in fabricated form; you simply convert your part and parcel of that large bar ownership into Maple Leafs or whatever you like.
TGR: What’s the premium for conversion?
JN: Simply the manufacturing premium of the coin and nothing more. In effect, suppose gold is at $800 and you’re buying your pool ounce at $803. That day you would have to pay something like $860 for a coin, so already you saved a tremendous amount because no one had to fabricate. The bar already exists and you own a portion of it. Two years later, even if the price stays the same, you just say you’d like 10 Maple Leafs for your 10 ounces of pool. The fabrication cost for Maple Leaf is 4% or whatever—so $32 a piece at that rate. Pay that, and shipping, and you have your coins.
TGR: If we’re looking at gold as insurance and keeping it as a percentage of our portfolio, what would be the value of converting it into coins? Long term, are they as valuable as CEF and ETF or a Kitco pool account?
JN: Yes, as long as you’re not doing apples-and-oranges and think of your gold allocation in terms of junior or not-so-junior mining shares, because then you’re really getting away from the concept. If it’s about gold per se as the vehicle, exposure is about the same whether you bought the ETF or the CEF or any of the products in Kitco pool and so on. The difference is your net cost up front, or ongoing carry cost with management fees, or your ability to convert in a pinch if you need any part of it in physical. As far as the wisdom of it, it would track very closely to the price of gold. For long-term holders, that’s an ideal situation.
Most clients who do this type of allocation look for three things. First and foremost, they want value for money. They’re not going to pay $3 or $4 over spot for silver when they can buy silver pool for maybe a dime over spot. They get a lot more metal for the money. Second, they really don’t want to hassle the custodial arrangements with uninsured bank safe deposit boxes. The third thing is liquidity. What good is your gold or silver holding if you cannot sell it in an instant?
TGR: We’ve spoken mostly about gold, a little bit about the U.S. dollar. How about the poor man’s gold? Silver has more industrial uses than gold does and we’re seeing a big gap in the gold-to-silver ratio. And silver coins are almost impossible to get now, compared to gold. How should investors be looking at silver?
JN: We’re not typically very big ratio followers. We don’t put a lot of weight on gold-oil, gold-Dow or gold-silver ratios and so on. These ratios have gone away from the historical norm of 16:1 or 20:1 and they’re probably not returning to anywhere near that. We gravitated for a while in the 40-to-60 area and got pushed close to the upper end of the 80s recently. It’s narrowed a bit, but I don’t see that it must return to a particular ratio and I don’t expect to see the 20s again. Even if we return to 50:1 or 60:1, that would be pretty okay, and 40:1 or 30:1 would be, wow! Like why not?
But in terms of buying, if the core position in gold is already in place and secured, I don’t see why one wouldn’t add a small component of a more speculative position in silver (because) to me, silver is a trade. It’s pretty much lost its long-standing monetary attributes. Having said all of this, if one is looking for a "play,” yes, I suppose silver has decent potential once the industrial side of the equation becomes alive and well again. And even if it does not, a 10% move on $9.50 silver might be a heck of a lot easier to take advantage of (in terms of time) than a corresponding $70 rise in gold. It’s all about odds.
TGR: But you’d put it in the same context as core metals, copper and such?
JN: Actually, I think it’s better because to some extent it retains a little bit of that monetary connotation, and some people do buy it as a hedge and protection. The expectation (I really should say "hope") we would have at this point is for the price to be somehow getting back to about $14.50 before we get into the second quarter of next year. We are at $9.50 today, so $14.50 is not at all impossible. It’s lagged because it relies on industrial demand unlike gold, where it’s strictly the monetary attributes being considered. And now we have the unfortunate overtones of the jewelry component coming into gold and saying, “Who’s going to buy that for Christmas?”
So the fact that silver lags could actually add more luster to it as we go forward. The SLV,if you look at the Exchange Traded Fund, basically holds about 220 million ounces and that’s a fairly steady sign, just like the gold ETF is steady. What I don’t know about iShares silver is what component consists of institutional and hedge fund speculative traders. We know with gold it’s better than half—it’s this fickle money as opposed to the man-in-the-street. I suspect silver could be the inverse. Maybe typical individual buyers are a larger component; that could be good news, because it would tend to lend stability to the fund in terms of long-term holdings and less volatility and fluctuation.
So I think it’s a very nice buy at anywhere between $8 and $10. If I were doing it, my objective would be to get out between $14 and $17. Could it go to $20 or $22? Sure. It already has early this year. $24 would be the top end as far as I can see at this time. At a certain price break, it becomes a headache for industrial consumers, as we saw with platinum at $2,300 and palladium at $600 and rhodium at $10,000. Right now they’re a fraction of what they were. I would expect car makers to come out of the woodwork and say, “Even for the long term, this is a great little place to accumulate some for inventory because we haven’t seen these prices in years on the noble metals either.” So, yes, they’re good adjuncts, but for different reasons. When it all comes down to it, gold dominates that safety and insurance policy, whereas silver has to factor in what happens in the global economy as well, which is right now the dominant theme, of course.
Jon Nadler, an oft-quoted industry spokesman in financial media worldwide, is Senior Investment Products Analyst Kitco Bullion Dealers. Jon has devoted some 30 years to the precious metals market and on its related investment products. A graduate of UCLA, he established and ran precious metals operations at major financial institutions (Deak-Perera, Republic National Bank, and Bank of America) and has consulted on marketing and product development issues to government mints, precious metals retailers, and trade and membership organizations such as the World Gold Council.
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