- Precious metals are fungible; they are mutually interchangeable just like money. Therefore, precious metals are the oldest form of money in the world.
When it comes to investing in precious metals, there are several ways to go.
Physical Bars and Coins
The purest way to invest in precious metals is to buy the actual metals. Bars and coins made of gold, silver, platinum and palladium, another precious metal, are available from coin dealers around the world. Gold bars are available in sizes from 400 ounces all the way down to one gram. Silver, platinum, and palladium bars also are available in a wide range of sizes and weights. When it comes to coins, many governments around the world mint coins, generally ranging in sizes from one-tenth of an ounce to one ounce that is legal tender in the nation that produces them. However, the prices for these coins move with the prices of the precious metals.
Precious metals bars and coins can trade at premiums or discounts to the actual underlying metal prices. These differentials result from the supply and demand for the bars and coins themselves.
When buying physical precious metals, it is important to locate a reputable company. Many dealers and banks advertise on the internet offering physical metals for the retail market. Compare prices between the dealers but be careful, anyone offering precious metals below the market price or at very low prices could be fraudulent. If you are uncomfortable with a dealer, do not purchase from them. It is always better to establish a relationship with a company that can supply precious metals and buy them from you when you choose to sell.
There are pitfalls when it comes to buying and selling physical precious metals, but this is the only direct route to ownership of the asset. As an alternative to taking delivery, some dealers will offer to sell you these metals and hold or store it for you in either allocated or unallocated accounts.
An allocated account will assign you a particular bar or coin while an unallocated account is only a book entry of ownership. If the dealer goes bankrupt or out of business, the allocated account will protect your investment as it is a segregated account while an unallocated investment could become a credit problem and the dealer could default on your purchase.
Think of the precious metals market as a pyramid. At the top is the physical market and below are instruments that seek to replicate or move in correlation with the physical metals adding another level of risk.
Futures and Options
Futures and options on futures precious metals are derivatives. These vehicles are the next step down on the pyramid. Futures contracts trade on exchanges, and they have a delivery mechanism for buyers and sellers. Therefore, a futures position can become a physical position in the metals during the delivery period. A buyer or seller can control a precious metals position for a small down payment or margin.
Options on futures are also derivatives that give purchasers the right but not the obligation to buy or sell precious metals. Options are like insurance policies on price. Sellers of options act the insurance company while buyers are the insured party.
ETF and ETN Products
ETF and ETN products trade on stock exchanges and seek to replicate the price action in a precious metal. The most popular ETF products for this asset class are the GLD and IAU that replicate the price action in gold. The SLV is an ETF which tracks the price of silver and PPLT correlates with the price of platinum. Additionally, there are many ETN products in the world of precious metals.
Some will rise when the prices of specific metals rise and others will rise when the prices of those metals fall. Leveraged ETN products magnify the price action in the underlying precious metals. These vehicles are lower down on the pyramid as they are derivative instruments based on other derivatives such as futures and options contracts in precious metals.
Mining Equities
Another way to invest in the precious metals markets is to purchase shares of companies engaged in the mining for and production of the physical metals. These stocks tend to rise when metal prices move higher and fall when they depreciate. However, those buying mining equities assume additional risks aside from the prices of the metals.
The purchase of a precious metal mining stock is a bet on the management and specific producing properties of a company. If there is a problem with either, the price of the stock could diverge from the action in the underlying metals. Sometimes mining equities outperform the price action in precious metals, and at times they underperform.
When selecting an instrument in the world of precious metals, it is important to do your homework. The most direct route for investment is through the physical market, but the other vehicles offer varying degrees of ease and liquidity when it comes to entry and exit from positions. The thing to remember is to understand what you are buying and selling and the risk of your counterpart.