Kitco's Jon Nadler: Want to Buy Some Gold? Some Things to Consider


Jon Nadler, Senior Investment Products Analyst, Kitco Bullion Dealers, shares his thoughts with us in a two-part interview. In the first part Jon gave an overview of why he thinks an individual investor would want to buy gold or silver. In Part II, presented here, he weighs the various ways individuals can own gold.

Jon Nadler, Senior Investment Products Analyst, Kitco Bullion Dealers, shares his thoughts with us in a two-part interview. In the first part Jon gave an overview of why he thinks an individual investor would want to buy gold or silver. In Part II, presented here, he weighs the various ways individuals can own gold.

Jonís gold market commentaries are frequently quoted by the U.S. Canadian and global financial media and his 30-year career has focused exclusively on the precious metals market and on its related investment products.

TGR: Youíve covered various methods of buying gold. Could you also give the pros and cons of each one? And tell us what an investor should consider when looking at buying gold?

JON: Well, once theyíve decided that the asset class is desirable for their basket of assets, the exposure to gold can take a lot of different forms. Traditionally, most people were buying a mutual fund that orients itself towards gold, or an ETF, or mining shares, or just a handful of gold coins and go home with them.

In principal terms, I think coins and bars dominate the scene for the individual investor whose absolute priority is proximity to the physical material and perhaps an expectation of having to barter coins or employ gold as money down the road, and but Ė again, I am not a big believer in crisis Ė trading it for bread and gas. A small stash of gold coins or gold bars in fractional form is probably not an unwise buy, because at the end of the day it still does represent portable wealth, and compact portable wealth at that.

The pros for this type of gold would be global acceptability and relative low premium. And that ďrelativeĒ has a big capital R, because on the flip side, you are indeed paying 5, 6, 7, 8 and on up in terms of percentage points above the current price of gold to buy a gold coin or bar and take delivery of same. So the classic attributes are, again, portability, divisibility, liquidity. The negative features would be the high premiums and potential liquidity issues, if, in fact, you find yourself in a strange place that doesnít really accept the common popular coins, and perhaps wants to pay you less than melting value. The bars are basically the same idea; itís probably a little more difficult in letting go of a bar if you donít have certificates of assay and so on.

As for numismatic coins, I am really not a proponent because the premiums are far, far higher than conventional gold due to the supposed rarity of the coin, and youíre getting into areas of subjective evaluation and grading issues, all of which may not be enough to overcome this high surcharge. The reason theyíre being so heavily promoted is the fear of confiscation, which I personally donít feel is a material threat. So to pay the equivalent of $1,000 or $2,000 per ounce of gold today for a coin that is basically worth $700 to $800, I see very little worth in doing that. If youíre an avid collector and know what youíre doing, thatís fine; a lot of people find enjoyment in the hobby. But as an investment in gold, per se, I donít think so.

And then you have the ETFs, which are the relative new arrival on the scene; having entered in late 2004. The ETFs have amassed about 600 tons of gold holdings, which is a significant accomplishment. On an equivalent-size basis, theyíre about the 10th largest central bank out there, right ahead of China, I believe. But itís also a vehicle that I feel has given institutional players an entr√©e into this marketplace, and thus has probably altered gold market landscape just a bit. It has added volatility and other features that we are not yet fully aware of because, letís face it, thus far, itís been on a one-way accumulation mode and has grown and grown and grown.

But no one really knows what happens in a downward phase in a bear market, or what 600-ton hoarding could do to the market when substantial chunks of it were to be liquidated. Actually, I think it helps the market on the way up. We would hope it is longer-term holding, but if I look at the makeup of the ownership of these funds, I wouldnít be surprised to find a lot of institutional desks and trading desks and funds whose loyalty to gold may not be the same as it is with the individual investors. And the money underlying this may be fickle enough to leave once the profit objective is achieved.

So, itís not exactly what it appears to be. Itís a wonderful way to allow an institutional desk to participate at low cost and attract new players to the market. However, the individual investor doesnít look at it as a viable alternative to ownership of physical or custodial gold.

One of the drawbacks that I think theyíre looking at is the attrition of balances due to management costs being assigned against your ownership. It becomes a wasting asset, and your initial 100 ounces becomes less and less as time goes on. Then you have capital gains treatment; an ETF is not treated like normal stocks at 15% but at 28% like collectibles.

And some people have raised issues about custodians, sub-custodians, audits, and so on, which I am not necessarily afraid of as the issues, because I think that the trustees are doing their best to give the underlying physical gold its proper place in the vault. But to those who are concerned about credit risk, at the end of the day, yes, you are still taking the promise of a trustee to go out and perform that which he is supposed to do on your behalf as a gold buyer. And yet, you are buying a share of an instrument traded on a stock exchange, subject to all of those situational pros and cons with it Ė trading holidays, brokerage commissions if there are any. Itís ultimately going to be more like a stock and less like a gold coin.

So, the ETF has its place, and I think it will continue to grow, but I would like to see how it behaves in a two-way market at first and then see how much of the ownership makeup of this product is by Merrill Lynch and Credit Suisse and so on, and all the other institutions and pension funds.

For the moment, while I think ETF has cannibalized a good number of gold coin sales here and there, these other forms continue to be recording pretty nice sales numbers. And some of them are actually growing substantially in balances ó the Kitco Pool Accounts, the GoldMoney Program, and Perth Mint Certificates Ė all of which are not as new as the ETF, but certainly in terms of this bull market, they pretty much coincided with the advent of thereof.

TGR: How are the Kitco and the GoldMoney different from the ETF?

JON: The primary difference is you do not have ownership of a share of gold that is traded on the stock exchange. You have actual gold ownership that is held in a vault on your behalf. And the balances that you purchase at the outset are not impacted by any management costs assigned to you by any trustee, so youíre free of carrying costs, and your tracking of the gold price is literally penny for penny, dollar for dollar.

So the only thing you need to overcome is the initial price structure on the bid and offer spread, which is pretty minimal. Certainly in the case of Kitco Pool accounts it is less than 1% round-trip, and then thereís the interface of being able to trade these instantaneously online or via the telephone, and within 48 hours being cashed out if thatís what you need to do, or switch to another metal, like silver. Or, switch to another currency; you can redeem your gold into Euros, British pounds, or Canadian dollars.

I think none of those are doable with the ETF. And one of the more important features is definitely not doable with the ETF, which is your ability as the holder of the Kitco or GoldMoney goldgrams to redeem your balances in physical gold product, coins, small bars, and only incur a small fabrication or shipping cost. And thatís it. So converting to physical is very easy with custodial gold, but not so easy with ETF; in fact, itís not doable.

TGR: You mentioned that there is no management fee like you have with ETF, but there must be some type of carrying cost to put it in a vault somewhere.

JON: Really, the only time you have a carrying cost for a custodial arrangement is if you choose the allocated guise of ownership. Letís say the Perth Mint Certificates Ė they actually have two flavors of the product. One is unallocated where you donít pay custodial fees, and your holdings are part and parcel of a large bar that is already in a vault, that is already allocated out on pallets. So, you donít have to pay any storage fees or any insurance fees.

But if you chose to segregate 50 coins and put them in a box with a label with your name on it, then yes, you would pay about 1.5% per annum for storage, insurance, and audit. In consumer terms, thatís first of all justifiable. You probably canít do much better by opening your own private storage account with a custodian like a bank or a Brinks or a similar arrangement.

So, thatís the attitude if you chose the segregation total allocation. GoldMoney, I think, basically subsidizes the custodial charges, and although you pay something on the order of 1.2 grams of gold a year, that still amounts to only $30 to $40. So, itís still not a terrible cost to bear, provided that you also recognize that the alternatives that people are thinking about as ďsafeĒ are really not safe. Taking coins or bars home and putting them in a bank safe deposit box leaves you in a completely uninsured guise. You have no insurance on those boxes if something happens at the bank, and yet people tend to believe that theyíre safe with them Ė and even those boxes have $60 to $70 or $80 charges per year.

So, there are ways to do this very efficiently and with no carrying costs, and really have only the small spread to overcome. If youíre trading-minded, or even if youíre long-term minded, the balances that these products have amassed are pretty substantial. The GoldMoney program has grown to about $230 million to $240 million in five years. Kitco's Pool Account Program has been around for a decade, and we really launched it after we had an actual website in 1995. By 1997 we were in the custodial product business, and itís definitely gone very nicely. Kitco just celebrated its 30th anniversary in business.

So, there are alternatives to taking the goods home. The three attributes that an investor of this insured orientation that I have described would seek would be value for money, safety while in custody, and of course last, but not least at all, liquidity Ė how easy would it be to sell when the price hits $850 or $900 or on a given Wednesday when you feel like selling?

Gold coins, as nice as they are, or bars in your possession or in custody, canít provide you those features because thereís a definite difference in buying gold at 7% over market versus 0.5% over market and paying 1% or 2% for storage or management fees and so on versus not paying anything and still have the safety of an insured vault. Of course, thereís also the difference in having to pack, ship, weigh, and take the best offer for shipping back 20 Maple Leafs to some dealer far away versus picking up the phone and saying, ďHey, Iím done,Ē and 48 hours later the funds are here. Youíve banked by wire, and you havenít even left your house.

TGR: Right. How does one get into the Kitco Pool fund?

JON: Kitco Pool is extremely easy. Basically, it is just signing up online or on the phone. You donít even have to fund the account initially; you can just open it and decide when. There are no minimums required in terms of purchase amount, which means you can embark on a system on an accumulation plan, which is very popular. People have a regular monthly purchase plan, and they literally use it as a savings account. Itís a very good strategy because you can cost-average over long periods of time, and obviously if you get more ounces at a low price and fewer at higher, you will probably end up better off than the fellow who tries to hit the top and the bottom, thinking, ďAh, ha,Ē and they may miss it by 5% or 10%. And so it gives you that flexibility.

It also gives you the ability to switch from one metal to another or to redeem for another currency if that is your desire. You can take payout in dollars or in other currencies. Checking balances and all of that is as easy as with your online checking. You just log in, use the main password, and see exactly what you have and know what itís worth any time, day or night.

Basically the same with the GoldMoney, except for some limitations Ė you can only do it by Internet, not by phone, and some of the payment methods that Kitco accepts are far more flexible. GoldMoney really only does wire transfers Ė period.

But other than that, theyíre both digital forms of gold, and theyíre all backed by physical gold in actual vaults on actual pallets. Perth Mint is a little bit different because there the interface. The actual evidence of your gold ownership is a certificate that you receive and that you hold onto. It proves that you hold gold at that mint. Its minimum is $10,000; the subsequent minimum is $5,000. So itís designed as a long-time accumulation vehicle with a little bit higher net worth individual in mind, perhaps. But itís also ideal for people who say, ďYou know what? I really like the appeal of Perth; itís a century-old mint Ė 109 years, actually Ė in a very remote urban area on earth, thought to be very safe from all sorts of trouble." And because of the ownership of this mint by the provincial government of Western Australia, you effectively have a dual layer of insurance and guarantees that would tend to make you hold in the event of some mishap at the corporate arm, which is the mint. And thatís additional peace of mind for a buyer.

TGR: Very good. I think weíve covered quite a bit. We really appreciate your time and your insights.

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