Gold and Silver as Savings, How They Work and the Risks Sellers Don't Mention

If you have ever listened to a late-night ad for gold, you know the genre. A solemn voice. A graph that goes up and to the right. A warning that the world is about to end, followed, with remarkable coincidence, by a toll-free number. The sales pitch for precious metals is the only product in America where the first thing they sell you is the apocalypse and the second thing is a coin.

I like gold. I like silver. I think the instinct that leads a family to put a little something in a drawer that no government can print more of is a sound one, and it has a long and honorable history. But I also think a saver deserves the whole story, including the parts the person on the other end of the phone would rather skip. So let us do this the way a sensible person should: how the thing works, what it costs, what it does not do, and how to spot a pitch that is working on your nerves instead of your interests.

One clear statement at the start, because it belongs there. This is general information, not a recommendation to buy or sell anything, and it is not tax, legal or investment advice for your situation. For that, talk to a licensed professional who is not paid by the sale.

Why people hold metal at all

Start with the virtue, because there is one. Gold and silver have been money in one form or another for thousands of years. The Founders knew it. When they wrote the Constitution, they gave Congress the power to coin money and regulate its value, and in Article I, Section 10, they forbade the states to make anything but gold and silver coin a tender in payment of debts. You can read the first of those in Coin Money and Regulate the Value Thereof, the Founders' Monetary Clauses. The men who had watched paper money collapse in the Revolution wanted something a legislature could not conjure.

A piece of metal has no counterparty. Nobody owes you a gold coin the way a bank owes you a deposit or a company owes you a bond payment. If you hold it, you own it. It cannot be diluted by a new issue, and it cannot default. In a world of paper promises, that is a genuine property, and it is why many people consider a modest amount of physical metal as a form of insurance against the failure of paper.

That insurance idea is the honest case. Metals are a hedge against a bad outcome, not a sure path to riches. Keep that in mind, because the rest of this column is about the price of that insurance.

What metals do not do

Here is the part the sales pitch hurries past. Gold and silver, held as bars or coins, do the following things: nothing. They sit there.

1. They pay no interest. A savings account pays interest. A bond pays interest. A coin pays you nothing for holding it.
2. They pay no dividends. A share of a business may share its profits with you. A bar of metal has no profits to share. It has no employees and no earnings.
3. They produce nothing. A rental house produces rent, a farm produces crops, a company produces products. Metal produces nothing but the hope that someone will later pay you more for it than you paid.

So the whole return from owning a bar of gold has to come from one source: a higher price when you sell. If the price goes up, you gain. If it stays flat, you have earned nothing for years, and you have paid storage costs to earn it. If it falls, you lose. For a lesson in what a patient saver does with an asset that actually pays, see Compound Interest Year by Year, the Arithmetic That Rewards the Patient Saver.

The price itself can swing hard. Gold and silver have both spent long stretches in history going sideways or falling, and silver in particular is far more volatile than gold, partly because it is also an industrial metal. Anyone who tells you the price only goes up has never looked at a long chart. The past forty-odd years contain stretches where a buyer at the wrong moment waited a very long time to get back to even. I will not quote you a price, because a price in a column is stale the day it is printed. Look up the current spot price from a reliable source before you do anything.

How the money is lost: spreads and premiums

Now the cost, which is where the mechanism gets interesting. Most buyers have heard of the spot price, the price of a raw ounce traded in the wholesale market. Almost nobody pays it.

Here is a labeled, hypothetical example. Suppose the spot price of gold is $2,000 an ounce, a round number invented for arithmetic only. A dealer sells you a one-ounce coin at a premium of 5 percent over spot, so you pay $2,100. The same dealer will buy a coin back at a price slightly below spot, say 1 percent under, so $1,980. The gap between what you paid and what he will pay you is the spread, and on those figures it is $120, or about 5.7 percent of what you paid ($120 divided by $2,100).

What does that mean? It means the price of gold has to rise by about 6 percent before you break even, even on a perfectly honest transaction with a reputable dealer. Spreads on different products vary a lot. Larger bars generally carry smaller premiums per ounce than small coins, because there is less manufacturing and handling per ounce. Small coins and fractional sizes carry higher premiums. Silver, being cheap per ounce, often carries a much larger percentage premium than gold, because the cost of making and shipping a coin is a bigger share of a smaller price.

Then there are collectible and numismatic coins, which are sold as rare, graded and historically significant. The premium on those can be far above the metal content, and the resale price depends on a collector's market rather than the metal. Some of those coins are wonderful objects. But a saver who wants the metal should understand that he may be paying mostly for the story, and a dealer's story is not a store of value.

Coins versus bars

If you decide to hold physical metal, there are two main forms.

• Government-issued bullion coins. The United States Mint has produced American Gold Eagle and American Silver Eagle bullion coins since 1986, and the Gold Buffalo, a 24-karat coin, since 2006. Their weight and purity are guaranteed by the issuing government, they are widely recognized, and they are generally easy to sell. That recognition is worth paying a bit extra for. The face value stamped on them is a legal-tender amount that has nothing to do with their value as metal.
• Bars and rounds from private mints. These often carry lower premiums per ounce, particularly in larger sizes. The trade-off is that you must be sure of the maker's reputation and, for bigger bars, you may need to have them assayed when you sell.

In both cases, buy from a seller with a long, verifiable record, get everything in writing, and keep your invoices. Check that the product matches the description before you hand over money, and never buy from a stranger who contacts you first.

Storage and insurance

Metal has to live somewhere. That is a cost, and also a risk.

1. At home. The cheapest option, and the riskiest. A home safe can be stolen or burned, and your homeowner's policy may cap the coverage on valuables such as coins, so ask your insurer what the policy actually covers. A coin hidden so well that your heirs cannot find it is not an asset.
2. A safe-deposit box. A fee each year, and typically not insured by the bank for the contents. Check the terms.
3. A private depository. Professional storage, often with insurance, for a fee that is usually a percentage of the value or a flat rate. It is real security, but you are paying that fee every year against a metal that pays nothing, so the carrying cost matters.
4. Whatever you choose, keep a record. Write down what you hold, where it is and who knows.

A friendly reminder that the old joke applies: the best place to hide your gold is somewhere you will remember when you are seventy. The second best place is not "under the third floorboard, don't tell anyone."

Taxes, in general terms

I am not your accountant, and I will not tell you what to do. But a saver should know that the tax treatment of metals is different from stocks.

In general, the federal tax code treats gold and silver coins and bullion as collectibles. Under the collectibles rules, long-term capital gains on collectibles are taxed at a maximum federal rate of 28 percent, which is higher than the top rate on long-term gains from many ordinary investments. A gain is only recognized when you sell, and short-term gains are taxed as ordinary income. Dealers must report certain large cash transactions, and you should keep the records of what you paid, since you will need that figure to calculate a gain. The details change with the law, and your state may treat sales and capital gains differently. Check the current rules with the IRS or a qualified tax professional. That is the sort of thing where reading an old column is not enough.

Metals inside a retirement account

Some savers want metal in an IRA. That is possible, within rules.

1. The code generally treats collectibles bought with IRA money as a taxable distribution, and it carves out specific exceptions for certain gold, silver, platinum and palladium coins and bullion that meet purity standards, including American Eagle coins.
2. You cannot hold the metal yourself. The law requires that the assets be held by a trustee or custodian, so a "home storage IRA" pitch deserves a hard look and a call to a tax professional before you act.
3. You need a custodian who handles metals, and a depository that stores it. Both charge fees, often an annual account fee and a storage fee, and the dealer who sells you the metal charges a premium.
4. Ask for a full written fee schedule before you open the account: setup, annual custodian fee, storage and insurance, transaction fees, and the cost to sell or ship out.
5. Know that a rollover has its own rules. Moving money out of a workplace plan has timing and tax rules. Read how How a 401(k), a Traditional IRA and a Roth IRA Really Work, in Twelve Questions explains the account types before you decide, and then ask the custodian and a tax professional, not the metals salesman, whether the move makes sense.

The point is not that metals in an IRA are a bad idea. The point is that the sales literature rarely adds up the fees, and the fees on a non-income asset eat into a return that was never guaranteed to begin with.

How the pressure pitch works

You can recognize a pressure pitch the way you recognize a bad restaurant: by the way the host talks. Warning signs include the following.

• Fear first, product second. The pitch opens with a collapse and then offers metal as the answer. An honest dealer can tell you what he sells without scaring you.
• A deadline. "The price changes tomorrow." "Only a few left." A real market does not close on the day you are invited to buy.
• Unsolicited calls and emails. A seller who finds you has already chosen you for a reason. You should be the one to look for a seller.
• Promises of guaranteed returns, or "it can only go up." No such guarantee exists.
• Steering you toward rare or collectible coins when you said you wanted metal, because the markups are bigger.
• A refusal to show you the buy-back price, in writing. If you cannot see the spread, you cannot judge the deal.
• Pressure to move your retirement money quickly, or to pay in a way that cannot be reversed.
• Special "government" language suggesting that your savings are in danger of seizure and that you must act at once. That is the oldest trick in the book, and I will come back to it.

If you meet two of these, hang up. There is no rush. Metal has been valuable for thousands of years, and it will be valuable tomorrow. If the deal is good tomorrow, it is good next week, and if it is only good today, it was never good.

What history teaches, honestly

That brings me to the argument that appeals to savers who distrust paper. In 1933 the federal government ordered Americans to turn in most of their gold, an episode told in Executive Order 6102, the Spring Americans Were Ordered to Turn In Their Gold. It is a real chapter, and a reasonable person can draw a lesson from it about the danger of trusting a government with the final word on money. Another lesson, discussed in Gold standard, Friedman's rule or today's Fed, three answers compared, is that economists who care about sound money disagree about whether gold itself is the answer.

Be careful about the leap, though. The fact that something happened once does not tell you the odds of it happening again, and a salesman who invokes confiscation to sell you a coin is using history as a lever. Metal as a modest hedge is a defensible idea. Metal as a plan to put your whole retirement behind a fear is not.

A sensible way to think about it

Folks, the ordinary person's savings plan is boring on purpose. Build an emergency fund first; Why the Emergency Fund Comes Before Every Other Money Goal You Have explains why that comes before nearly everything else. Pay off the high-interest debt. Put money regularly into accounts that pay you for waiting. If, after all that, you want a small slice in physical metal as insurance, buy known products from a reputable dealer, know the spread, plan the storage, and never put in money you cannot afford to leave alone for years. A slice, not the whole pie.

The case in brief

1. Gold and silver are an ancient store of value with no counterparty, which makes them a reasonable hedge against the failure of paper, but a hedge is not a sure profit.
2. Metals pay no interest or dividends and produce nothing, so every dollar of return has to come from a higher price when you sell, and prices can fall or stay flat for years.
3. Dealer premiums and the spread between buying and selling prices, illustrated here with a hypothetical 5.7 percent gap, mean you start behind and must gain before you break even.
4. Storage, insurance, the collectibles tax treatment and the custodian rules for metals in a retirement account all add costs and constraints that sales literature tends to leave out.
5. Pressure sales built on fear, deadlines and rare-coin markups are the warning sign, and the cure is to slow down, ask for the buy-back price in writing and talk to a professional with no commission.

What you can do: before you buy any metal, call two dealers, ask each for the buy price and the buy-back price in writing, and compare the spread.