Recently I was asked if an investment strategy should include precious metals, specifically gold and silver. There are a number of factors to consider when answering this question because recently investments in gold and silver appear to be a response to fear and not rational thought. The first aspect of precious metal investing you should consider is the buy-in / sell-out price. When you go to a precious metals dealer, keep in mind that the dealer is in business to make money. The typical purchasing process incorporates that fact in the buy price. Thus, dealers must sell above their costs and often times above the spot value of the precious metal. This means that precious metal dealers sell at a premium. Conversely, when a dealer buys from the customer, he will often reduce the price he is willing to pay. This means that precious metal dealers buy at a discount. The spread (the amount of money between the purchase price and the sell price) is the profit for the dealer. Basic economics, but it is amazing how many lay people who purchase precious metals fail to calculate this into the process. When you, the customer, purchase gold or silver above the spot price, you are increasing the amount of your investment costs. Thus, the spot price of the precious metal must increase in order for you to cover your costs. However, the converse is also true that when you sell the dealer will buy at a discount. This means that not only do you need the spot price to increase to cover your purchase premium, but it also needs to increase enough to cover the discount. On 3/5/2013 at 6:55:35 AM the bid price of silver was $28.83 and the ask price was $28.93 per ounce. On the same day the United States Mint was selling the one ounce American Silver Eagle coin for $50.95 per coin. If you were to purchase one American Silver Eagle from the mint (at $50.95) and you tried to sell it to a dealer (at some price below the $28.83 price) you would take a loss of nearly 50 percent. This is the first concern that anyone who is considering investing in precious metals needs to understand. The second concern is closely related to the first. Any investor needs to understand the fluctuation of metal prices. In uncertain times, metal prices can be wildly erratic. It is a real possibility that on the day you need to sell your metals, the price drops precipitously and on the day you decide to buy, the price skyrockets. These price fluctuations can significantly impact your return on investment. Couple this price fluctuation with the premiums and discounts of the precious metal dealers and you can begin to see why it is a questionable strategy to invest in gold and silver. However, there is another concern to consider. The areas affected by Super Storm Sandy and Hurricane Katrina give us an example of failed economies. The argument used to support investing in gold and silver is often the concept of a failed economy. Having precious metals in a failed economy is nearly useless. When an economy fails food, fuel, and water become the most important commodities. Actually, lead and copper will likely become more valuable than gold and silver in a failed economy because you cannot hunt with gold and silver. I have never seen a gold coin kill a deer. Additionally, think about what backs gold and silver; the American dollar. And if the dollar collapses, what would gold and silver be worth? Let’s carry that thought one step further. Today you use fiat currency to purchase gold and silver. When you sell your gold and silver you get back more fiat currency. One could make an argument that you are using a medium of exchange that is backed by nothing to purchase metals that are backed by the very currency that is backed by nothing. Going back to the original question: Should an investor consider investing in precious metals as part of a larger investment strategy? I would not advise it. However, if you find yourself wanting to purchase a little gold and silver, I would suggest purchasing the tangible asset and placing it in a safety deposit box at your local bank. Do not open a gold retirement IRA. Precious metals are already tax-sheltered. The only time you are required to pay taxes on the physical asset is when you sell the asset at a profit. (Did I recommend you retain all receipts for any precious metal purchases?) Therefore, it seems redundant to hold tax favored physical assets in a tax favored account. If you are tempted to open a gold IRA, ask yourself this question first. “What is in it for the manager of a gold IRA?” If you must have gold and silver, take your time and shop around to find the right price at which you are willing to enter the market. Hold the physical asset in a safety deposit box, and only use money that you will not need in the next ten years. Be aware that owning gold and silver can give you a false sense of security. Be very aware of commercials that hype the price of gold up to $10,000 in the near future. Investing needs to be rational and investing in precious metals is more about emotions than rationale. I would advise against taking the emotional rollercoaster ride and instead stick to investing in solid, consistently performing companies.