Reader Questions: Precious Metals
Today we’re kicking off a new series here at Mr. Tako Escapes. — Reader Questions. That’s right, I’m starting a series of posts dedicated to answering the most interesting reader questions sent my way!
Got a questions you want answered about investing, dividends, my life, or even food? Shoot me an email using the contact page!
Our first reader question comes from reader ‘Meg’ (not her real name), who’s recently suffered some pretty steep investing losses, and wants some advice. Reader Meg writes…
Dear Mr. Tako,
By accident, I recently stumbled upon your blog. I really enjoy your common sense, no-nonsense approach to living life frugally while still having a good time.
I’m making some big decisions which will affect my upcoming retirement, but I recently lost almost 50% of my money on a silver investment. The investment was recommended to me by an old friend who generally is very savvy with money.
I wanted to ask you — How do you feel about investing in gold, silver, and other precious metals?
Yikes! That’s a rough loss Meg, and I’m sorry to hear that it happened to you so near to retirement.
But, look on the positive side — this was a great opportunity for you to learn. Learning is what investing is all about, and exactly why I picked your question to kick-off my first “reader question” post!
So let’s get down to it!
Precious Metal “Investing”
Since the dawn of time, mankind has been obsessed with shiny precious metals like gold, platinum, and silver. For the longest time man minted these metals into currency, melted it into jewelry, and showed it off as a symbol of wealth and power.
For the longest time, gold and silver ACTUALLY WAS MONEY until the governments of the world decided to move completely to fiat currencies.
Unfortunately, precious metals have too long a history for humans to really think clearly about it. The stuff makes the minds of otherwise intelligent men and women go completely crazy.
Precious metals are now mainly used to make jewelry, bars or coins, high-end electrical connectors, and some dental and chemistry applications.
So, does Mr. Tako think of precious metals as an investment? Well, to first qualify as an “investment”, it has to pass my Asset Test.
People define ‘assets’ in a number of different ways — Merriam Webster defines it as ‘an item of value’. Dictionary.com defines it as “a single item of ownership having exchange value.”
Honestly, I could care less about how various dictionaries define the word.
My definition of an asset is a little different — When it comes to the world of money, I see three kinds of pieces on the gameboard of wealth — assets, liabilities, and commodities. Can you tell the difference between them?
I define an asset as: A thing which generates cash flow, outside the buying and the selling of the thing itself.
Liabilities (of course), do the opposite. They consume cash flow outside the buying and selling of the thing.
Metal of any sort (shiny, precious, or otherwise) falls into the commodity category. One piece of metal is perfectly equivalent to another piece of the metal of the same size and quality. That’s a commodity.
Commodities have prices too, just like assets and liabilities. The price of that commodity is mainly governed by supply and demand, but investor speculation can also move the price from time-to-time.
What you WON’T hear me say is that precious metals are assets. They’re not! (at least how I define assets)
So, when people say the words “investing in silver” or “investing in gold”, I just have to facepalm. Investing is the buying of assets, NOT liabilities OR commodities.
Making Money In Commodities
Don’t get me wrong — it’s entirely possible for people to make money trading in precious metals or liabilities. People do it every day. But, 90% of the time it’s PURE SPECULATION that the price will rise or fall.
They either get lucky, and the price goes up! Or, they get unlucky (like our reader Meg), and the price goes down.
Very few individuals have the data and inside information necessary to understand the intricate economics that will affect the price of precious metals over the next 5 years.
Precious metals are simply a store of value… the price of which will be governed by supply and demand whenever you buy or sell that commodity. Think of a store of value as very similar to cash (except cash usually declines in value because of inflation)
Gold or silver does absolutely nothing in your hands. I know people with vaults full of the stuff, and it never does anything but sit there.
One pound of silver will only be one pound of silver in 20 years time. It won’t spit off dividends or interest. That silver bar won’t suddenly reproduce and become two silver bars. It will never compound. That silver bar will always be exactly one pound of silver.
I personally have zero ability to accurately predict the future prices of gold, silver, or any other metal. (Most people fall into this category) For me, putting money into commodities is simply gambling.
Instead, I prefer to invest in assets. Assets that compound.
Stop Gambling And Start Investing
Now, I know all the ‘gold nuts’ of the world are going to disagree with me. I don’t have a problem with that.
They can show me the charts where the buying and selling of precious metals at “select” points in time will have outperformed stock investments (don’t worry, I’ve already seen these charts), but that won’t change my mind.
Why? Speculation returns rely strongly on luck (sometimes called random chance) to produce results. My approach tries to remove the ‘luck’ from investing (as much as possible).
Unfortunately, I’m not a lucky person. Where I’ve speculated in the past, I’ve both won and lost considerable amounts of money. Returns can’t be consistently earned over time — They won’t compound. They won’t feed my family, or fund my early retirement adventure either.
Instead, I need steady and predictable returns produced by assets, and the power of compounding.
I avoid speculation wherever possible. That’s not to say that people can’t make money at it — they do! It’s just not the way I invest.
So, I’m going to end this reader question with an incredibly instructive quote from my favorite investor, Charlie Munger**:
“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”
** Incidentally, Charlie Munger is the subject of a wonderful book I think every investor should read.
32 thoughts on “Reader Questions: Precious Metals”
Mr. Tako, I do feel bad for your reader. I can empathize because there was a day no so long ago (maybe 12 years ago) that I started to become a gold bug. I moved more than 40% of my equities into metal types of assets (physical bullion, ETFs, etc.). The good news (and bad news for gold bugs) is that the world didn’t implode and we didn’t hit a hyperinflation. Luckily, I got in and out relatively unscathed, but I also didn’t make a huge return after all of the speculation either. Today, I’m much more confident in our economy even in the most dire situations. And, if we do encounter complete anarchy one day, I still have a few silver pieces to barter with. 😉
Glad you got out with your shirt!
It’s interesting that ‘preppers’ often think they’ll use gold or silver to barter when the world ends. It’s possible, but entirely dependent on finding a “greater fool” to exchange a useless metal for something useful. Food and water are more likely commodities of exchange.
This is the first time I have heard the distinction between an asset and a commodity laid out so clearly. I think I have allowed the word “asset” to be a broad stroke word covering an array of items (including some liabilities and commodities). I really like this clear, set distinction. Thank you for sharing, Mr. Tako!
Glad you enjoyed it!
I’m in full agreement. Even commodities as a store of value is a bit of a question make. Sure some like silver are used in manufacturing so at least their is intrinsic demand. Something like gold’s value is simply based on perception (it’s not heavily used in manufacturing with some exceptions). So you also get situations like the 80s and 90s where gold tanked despite inflation.
Thank you for the great advice, Mr. Tako! I listen to the Dave Ramsey show, and he also advises against investing in gold and any currencies.
I know people in Asia like investing in gold since the emerging markets are oftentimes unpredictable and inflation rates are high. But I don’t plan to invest in metals any time soon.
I define assets a little more broadly than you, so I do think precious metals would count as assets in my dictionary.
However, I think their expected return would be inflation, so that means just about anything is a better investment. And, as your reader experienced, the actual return can be a train wreck. Extremely high volatility with extremely low expected returns is not a great way to build a balance sheet.
Nice post – looking forward to more reader mailbag!
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Oh my god, thank you for writing this. Mr. Picky Pincher is all about precious metals and wants to hoard gold like a dragon, and it’s been SO HARD trying to tell him why it’s not a good idea. Forwarding this article over to him now lol.
I hope it helps! Be careful too — Smaug can be cranky about his gold.
I would agree with people that say, “Gold’s price is based on people’s fear and greed”. Just fear and greed; pure speculation.
“Speculation leads to bubbles, and bubbles always pop” (c) MMM
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I like your classification of assets, liabilities and commodities. Actually precious metals have friction that tip them towards liabilities. You have to pay to insure and store your gold, if you don’t want to keep it in a home safe. And every time that you need to test or certify the gold to ensure the assay there is a fee associated with it.
A second question is would you consider non-dividend paying stocks to be more like commodities, or do you look at the cash flow and profit changes of the underlying company to be a proxy for cash flow, even if this is unrealized by lack of payment to the shareholder? Same question with zero coupon bonds. I think that would be incorrect but that may be the case from your definition listed so would appreciate your thoughts here.
Good questions Mike! Non-dividend stocks frequently do have cash flows, it simply gets reinvested into the business. That’s still an asset as long as you’re pretty confident those cash flows really exist. Compounding will actually happen.
Zero coupon bonds are kind of similar. Upon maturity you’ll get your principal + a defined return. That’s still qualifies as an asset, even if the cash doesn’t hop into your pocket at regular intervals.
Sorry to hear about your reader. That’s a tough loss right before retirement.
Currently, we don’t have any money in precious metal other than our rings. And those are on the cheap side, probably under $500. I agree with everything on this post. Gold is a commodity. I’d like to buy a little just in case the zombies take over, but it would be a very small part of our net worth.
Hmm… zombies are gold bugs too? 😉
That’s a tough loss, but hopefully a good learning experience for your reader. I like your way of classifying assets, liabilities,and commodities. Here you talk about owning silver and gold physically. What’s your view on owning precious metal producers? I suppose that’s owning an asset.
I think I would classify the mining companies as assets — The value is in the business (the machinery, the systems, people, patents, etc) not in the material itself.
Yikes, sorry to hear about your reader losing money on that “investment”. But as you said, mistakes are how we learn. We made the mistake of getting out of the market right after 2009 as it was recovering, and lost out on gains but it taught us a valuable lesson. No one lives through life without making a single mistake.
This is an excellent post and I especially love how you say :”So, when people say the words “investing in silver” or “investing in gold”, I just have to facepalm. Investing is the buying of assets, NOT liabilities OR commodities.”
This is absolutely true. It’s not an asset if it doesn’t generate cashflow. Great job explaining this concept so well!
That’s a really nice write up on gold and silver. I was into gold and silver also back in 2004-2011. In 2008 when the world was falling apart it seemed like a sure thing and with all the fear going around I did actually make a little money, but I got lucky. I sold most of my silver at $20 or so and then watched it go to $50 kicking myself all the way up. But then in 2011 when I saw gold making new highs and silver couldn’t make new highs, I got lucky and sold my gold close to the top. Gold & Silver were in a bear market for about 20 years from 1980 until about 2000. It could easily be in another bear market that long and I don’t want to have anything to do with it. Assets that produce things and/or pay dividends (stocks, bonds, farmland) are the way to go, no doubt about it.
Gold = Pet Rock, so yeah, not an investment! I oscillate sometimes on my view of it from a hedging standpoint. Because as a commodity, Ray Dalio has a small allocation towards it in his famous all weather portfolio. In an end of the world type situation, you’re better off having canned food, big drums of water, and a lot of ammunition. These things can be used for bartering. Not gold or silver bullion.
Warren Buffett doesn’t believe in investing in Gold either.
Nice and interesting article.
Since everybody agrees here, I just want to shine some light on the other side of the picture.
It is clear, that nobody should invest massive amounts of his capital only in gold. Much too risky, and if we consider physical gold, we are confronted with the safe storage problem on top of it.
But there are also advantages in gold investments.
No1 is correlation. Gold is one of the very few asset classes with low or even negative correlation to most of the other standard products like stocks, bonds etc.
When it comes to optimization of a good portfolio with high retuns and low risk (good Sharpe ratio), gold can offer some nice stabilizing effects without killing too much performance.
In my experience it is a good idea to mix in some 5-15% of gold, depending on what else you own and the individual personal situation.
And it isn´t only about physical gold.
We can also get some exposure to this market segment by investing in mining stocks. This is not a pure gold play, but it shows a blended charakter of a leveraged gold price, combined with some classic stock behavior, like dividend payouts.
Especially the southafrican companies with higher mining costs can be very volatile, so we should be careful and not feed too much capital to this sector, but as a small part of the mix it is not a bad idea IMO.
Then there are aslo synthetuc paper gold ETFs, cloning the price movement of the commodity almost 1:1, without physical storange problems.
Of course, these don´t pay any dividends, so again, keep the budget controlled for things like that.
I’ve always enjoyed your blog especially since you’re a stock picker — pretty rare in the PF blogosphere. I’m glad you’re starting this new series, and on a topic near and dear to my heart no less.
Your take on PMs is very common. I respect that and won’t try to dissuade you. But I do take issue with a couple points.
“Precious metals are now mainly used to make jewelry, bars or coins, high-end electrical connectors, and some dental and chemistry applications.” — This is true of silver. In gold, more than 1/3 of above ground stocks (https://schiffgold.com/key-gold-news/how-much-gold-is-there/), or >$3trn at today’s price are in central bank vaults or private hands as “monetary assets”. They are not “productive assets” by your test — again a very popular notion made famous by none other than Warren Buffet (who by the way, at one point was in silver in size http://www.cmi-gold-silver.com/monetarydigests/warren-buffett-buys-silver/).
One of your readers mentioned Ray Dalio and the all weather portfolio. Many truly modern portfolio construction methods such as risk parity, minimum correlation and maximum diversification are all about cross-asset correlations. This is where gold shines as it has zero correlation to both stocks and bonds. That’s why gold has a place in those portfolios even though its long term expected real return may be zero.
I have no issue with anyone calling PM investors “traders”, “market timers” or “gamblers”. I am all those and the names carry no negative connotations to me. In saying so, I accept the risks and understand the need for position size and risk control. Unfortunately for your reader Meg, she does not appear to. That’s a violation of the first rule in investing: know what you own.
My baseline PM allocation is 15% currently and I do trade around it. For whatever it’s worth, I believe we’re six weeks away from a major bottom in PMs.
I hope this comment can stay. It will be fun to check back later.
The 15% is exactly the value I found most practical when it comes to risk vs performance. It is on the high side of the typical recommendations, but anyone can backtest it in DIY style ( e.g. on portfoliocharts.com, where you can play around with all segments and see what kind of asset mix would have given which yield and siggma over the years.)
if someone is also invested in bonds/short term/ real estate etc., I would go down to ~5 %, because there is no need to “overstabilize”.
But if you operate very stock biased, some 10% gold in the mix or more is a good idea IMO.
You’re welcome to share your opinion of course.
For me, putting 15% of net worth into a non-earning commodity seems pretty silly. To each his/her own I guess.
15% would also be the maximum for me. Usually I would aim lower.
But regarding non-earning assets: One can also use Gold Mining stocks, which pay dividends, it doesn´t have to be physical coins all the time.
Of course, If someone is invested for an extremely long time, he can forget about risk, sigma and volatility at all, because after 30 years it most likely doesn´t matter. In this case we could in theory jumpstart with a 100% stock allocation with no gold or bonds.
But we all are humans and many people get nervous on the way up. There is also the emotional component. The more conservative assets not only mathematically buffer the portfolio, but also calm the mind.
Just a few days ago the classic movement happened :
Tech stocks like Apple, Intel, Applied Materials, KLA… fell like a stone.
At the same time : Barrick Gold, Newmont Mining , Goldfields etc. up
For anyone interested in a little bit of cyclical swing trading, this brings up some nice opportunities as well from time to time. Of course, that approach would be far away from the “Vanguard All In” style, but it´s always an individual decision. One can also combine both methods (like 50 % passive ETF/ 50% hand picked stocks), no problem with that.
The way you differentiate between money-earning assets and commodities that just fluctuate in price really makes this a simple decision. I think looking for values in both can be rewarding, and for me commodities are for dabbling in trading and stocks are for long-term investing.
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I have a Precous metals mutual fund it is way down now but that doesnt bother me because eventually what goes down must come up.
I own physical silver and gold not as investments but as a hobby. it is something i like to do. The value is of no effect to me except i wont buy an overpriced bar or coin.
I would venture that your reader bought the silver sometime either before 2011 or shortly their after and at that time lots of people thought that it was going to skyrocket at that time. I would tell her not to panic and to add to it every once in awhile
If you look historically a silver dime would almost always buy a gallon of gas except for a few small occasions.
Is your readers investment in a mutual fund ETF or physical silver that she can hold? or maybe a mining company that specializes in silver?
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She didn’t specify any specific investment type, just ‘silver’.
Besides gold and silver, I love how people also ‘invest’ into homes (your own one, like a new kitchen, not rentals), cars, jerseys, bitcoin, art, wine, appliances… the media is full of it.
Just wanted to offer another viewpoint to Mr Tako. (I just discovered your blog through Millenial Revolution and can’t wait to read more.)
My husband works at the family jewelry store as a gemologist, manager, salesman, etc. He handles all of the purchasing of gold and silver that people bring to sell to the store. This is done through the store (not personally) and he offers them an amount based on the daily price of the metal. The scrap metal is then usually sold to a refinery (still at less than its actual “price”) and coins are sold to his contacts in the coin business.
We have done well personally with buying at low points and selling at high points, but he is literally in the midst of it every day and has multiple contacts in the business. I would only recommend investing in gold and silver if you have a similar job, want to diversify into something “cool” with some extra cash, and/or can trust a local jeweler. He has a sad story for me almost every week of someone realizing they were ripped off by a bullion or coin company when they come into the store to sell their “investment.”
I think gold and silver can be a good tool, but only if you know what you’re doing with it and don’t treat it as an “asset.”
I’m so with you on metals not being an asset. Every time a coworker with no retirement accounts brings up the question about “investing” in gold, I get very nervous for them. It is so speculative and risky. I’d rather have easily liquid assets that grow in value.