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Financial Crisis Worst Case Scenario- How Should I own Gold?

Commodities / Gold & Silver Sep 30, 2008 - 06:12 PM GMT

By: David_Haas

Commodities Best Financial Markets Analysis ArticleEditor's Note: This article is written to address “worst-case” scenarios that should be considered as part of a comprehensive strategic wealth management plan. The author does not anticipate or predict that any such scenarios would or will materialize. However, planning for the worst while hoping for the best has always been excellent advice in both personal and business strategy and prudent planning may secure options for those who have planned appropriately. While reading, bear in mind that the probability of a worst-case scenario developing is always greater than zero and there are times when such a probability is considerably higher. Current events would appear to be raising the likelihood of financial and societal problems more severe than have been experienced in several generations.

A s anticipated, gold is becoming more and more fashionable now because we are finally at the point in the long-wave credit cycle when masses of people start thinking in earnest about “worst-case scenarios” and begin seeing tangible reasons to believe the perennial prognosticators of gloom and doom.

Gold has traditionally played a critical role in portfolio theory as “portfolio insurance” - to act as a counterbalance and guard against the possible melt-down or vaporization of paper wealth that may accompany war, political instability or revolution, hyperinflation, or simply a loss of confidence in a paper-based financial system as we're experiencing now. The traditional investment guideline has typically been that holding 10% of your assets in gold (and other precious metals) could help to offset most or all of a loss incurred with a substantial meltdown of the paper asset classes.

It's interesting to note that we're now witnessing two (war, paper meltdown/systemic loss of confidence) of the four major reasons to own gold that I mentioned above. It's always possible that, should these two expand or become widely intolerable, a third or fourth could be hot on their heels.

Judging by the degree of overt anger and frustration we're reading about on the internet and feeling first-hand in conversations with fellow Americans, I'd say we've had a very close brush with upheaval already due to the near-passage of the Paulson-Bernanke “Emergency Economic Stabilization Act of 2008” and we're still not out of that woods. Either way, unbearable economic duress bearing down on a large enough portion of a population will surely lead to some disruption and it's fair to say that the federal government is preparing for it via actions like this: Pre-election Militarization of the North American Homeland.

So, with all of the above potentially developing around us, it's quite understandable that a larger and larger number of us are discovering gold as a possible hedge against the uncertainties of the future. Notice that I didn't say a “predictable” hedge. I intentionally avoided the word predictable because I cannot say with certainty that gold will be an effective hedge and, at best, I'd be willing to predict that gold will be volatile. All I can say with certainty is that gold HAS ALWAYS BEEN dependable as a safe-haven in previous times of trouble and many well-informed people believe it will be again.

What could go wrong for a holder of gold? A variety of things. First, we could go into a severe deflationary scenario that sweeps away much of the money that was created during the credit bubble years making cash scarce. This could be an environment that brings the prices of nearly everything crashing down around us, including precious metals. Another thing is that the government could strong-arm our gold away from us - as has been done before.

If economic conditions become desperate for our country and it needs to establish a new monetary system based upon “trust”, what better way to regain the respect of the world than by backing our new currency with gold just to prove that we've come to our senses and learned some discipline? In this instance, it seems that the government would be grabbing gold wherever it could find it. With modern technology, don't fantasize that you'd be very effective at hiding your gold unless you just happen to own a junkyard full of old cars and scrap metal to hide it in. Even so, government might be setting “official” gold prices at that point in time so you'd have little market for your hoard other than them or a black market, if one formed.

Finally, we could probably come up with plenty of other threats but here are two of the most challenging; you must hold enough gold to replace the wealth you lost through the destruction of your paper assets, BUT you must also be able to carry it with you and spend it if you were forced by circumstances to leave your area. If you have a lot of gold, you may not be able to carry it with you because it's very heavy (at today's prices, roughly 8 pounds per $100,000). If you need to spend it, how will you prevent people from learning that you have gold and, furthermore, how will you break it into small enough portions to get a fair deal on the day-to-day things you may need to trade it for in the marketplace?

I don't claim to have all the answers, and I have to remind you that I'm not free to offer any form of advice to anyone who reads my blog, so please don't misconstrue anything I say as advice . But, there are plenty of ways to own gold and my thoughts are that it would probably be best to “mix and match” several of the categories I list below to accomplish several different objectives. I'll add brief comments on the advantages and disadvantages of each as I go along. Also, bear in mind that there are probably other ways to own gold but I'm just hitting the major options here.


Dust, nuggets, bars, jewelry, coins, wire, etc.

- Dust is highly-divisible but easily contaminated, adulterated, or lost. Imagine if you dropped it in some tall grass or on rough pavement or gravel! Also, the low “trust factor” with others might mean that it would be hard to trade at full value. I also don't know where a person buys gold dust, though I'm certain many of you do. Due to these limitation, gold dust wouldn't be one of my personal choices.

- Nuggets of a variety of sizes could be a nearly ideal way to own gold. It would behoove you to also own a gold purity test-kit to prove the value of your gold to others as well as to test the purity of gold you might buy. This would also apply to jewelry and dust, as well.

- Bars are available in a wide variety of sizes and have definite advantages such as a purity stamp, a standardized size and weight, familiarity, compactness, spill-proof, etc. The primary disadvantage might be that they are difficult to break into a smaller form. Remember the thousand dollar bill? Did you ever try to get change for one in the worst part of town? Imagine that nearly every place could be “the worst part of town” in a depressionary scenario that would require you to rely on your gold stash. This disadvantage can be overcome by purchasing some very small bars (1 gram, 2.5 grams, etc.) but then you begin paying more in transaction fees again. One dealer I've seen who sells these smaller bars is:

- Jewelry can be very good or very bad. First, people notice it on you right away if you're wearing it and it may be perceived as having a much higher value than what it's really worth due its design. Some jewelry is looks heavy but may actually be light in weight or contain very little gold. Jewelry is highly desirable and may place you in constant physical danger in an environment inhabited by throngs of desperate people. On the other hand, gold chains are nearly perfect to clip links from and trade for the things you need with “exact change”. Rings, earrings, pins, watches, etc. would all rank far behind chains, in my opinion, and gemstones would be of questionable value to the average person since only experts know how to verify their authenticity and value.

- Coins are generally of two types, the numismatic or the non-numismatic. Numismatic coins carry an extra premium due to rarity, desirability, collectability, and/or exceptional beauty. These coins can fluctuate in value with a great deal of volatility as market conditions change due to their premium being based upon conditions above and beyond the intrinsic precious metal content. This extra premium, known as the numismatic value, can increase or decrease greatly with changes in the marketplace. Numismatic coins gain be a great way to speculate for those who would like to magnify future price gains they anticipate in the market and, an additional use for numismatic coins is for wealthy people who need to pack as much wealth as possible into the smallest possible package. In this sense, certain numismatic coins are similar to high quality diamonds or other gems that are highly valued.

Non-numismatic coins are owned mostly for their certified bullion content and their appealing design. People recognize them (Eagle, Krugerrand, Maple Leaf, etc.) for their popularity and trust them due to the certainty of the backing of the mint that made them. I like this type of coin for investment because they're a great way to have something beautiful to look at, hold, and enjoy (even if the world doesn't fall on its ear) but also because they have a very small mark-up or commission through dealers. In the coin world, they're considered more as a commodity, like bars are, and they're traded and sold in similar fashion with minimal mark-up and can easily be shopped between dealers to nail down the very best price.

- Wire is possibly the best-kept secret for those who think they may have to actually use their gold for exchange or barter. Wire can be purchased through a good jeweler or jewelry-supply house and it doesn't have to incur a large manufacturing or retail mark-up like most jewelry would. A jeweler can likely be found who would order the amount you require at a small mark-up. The wire can easily be hidden with other value-less objects and wouldn't need to attract any attention whatsoever. For trading, what could beat it? You could carry it in your pocket or wrap it on your wrist, uncoil a piece, and snip it off onto a scale with a wire-cutter. Need a little bit more to balance? Snip just what you need. Almost perfect. Times look bright and you need to get your money back? Simple. Either sell it back to a jeweler or mail it in (insured) to a smelter who'll send you cash via the USPS or Fedex. The smelter does an assay on the gold you submit and very carefully weighs what you've sent him and pays you promptly. This is also great method for getting your money back from gold jewelry (or any other precious metal) without paying a high commission or taking a sharp haircut from a local dealer or pawnshop.


- Gold stocks usually come in 2 flavors – major gold producers and “juniors”. Both involve the usual risks of the stock markets and they also introduce business risks in the form of poor management, heavy indebtedness, over-expansion, overpaying for properties, exploration uncertainties, increasing production costs, and more. For these reasons, gold stocks, in general, tend to be considered far riskier than owning the metal directly but they also provide a great deal of potential leverage when market prices move upward. Major producers “tend” to own established mining properties and spend most of their time and effort developing the resources they already own. Majors typically expand by purchasing new “proven” properties as well as by purchasing other smaller producers with good properties and acquiring operations in need of better economies of scale to increase profitability. Majors tend to be stable (in a business sense), yet cyclical investments and are widely held by mutual funds and institutional investors.

- Juniors, in contrast, remind me of the wild, wild west of the 1800's in America. Though these rough-and-tumble companies operate around the globe, they offer up many potential surprises – both good and bad - for investors. Many juniors are truly hot little companies that have “struck gold” somewhere on Earth. Juniors can quickly go from making a killing in a strong gold market to frantically looking for cash to survive when times aren't so good…and back again! This means that investors who get into a good company in the “lean times” often pay pennies for shares of a company whose price may run up into the $10-20-30-40-50+ range when the gold market is frenzied. Perhaps the biggest challenge for would-be investors in junior mining companies is sorting out the facts from the fiction. In their hard-to-regulate and nearly lawless world, they have been known “spin a few yarns” to bring new dollars in the door. Sometimes that same money is running right out the back door! If you know what you're doing, fortunes can be made quickly with the juniors, however, even seasoned professionals have been badly burned. The best approach is diversification and, of course, “buyer beware”. Investing in juniors should generally be viewed as speculations.


- Professionally managed funds (mutual funds, closed-end funds, some ETF's) can help keep investors out of trouble by providing the resources and expertise to thoroughly research companies they invest in. These fund managers are often specialists in mining companies and who have gained their expertise through many years of learning the industry from other experts and analysts they share news with. Some funds hold physical metals as a part of their portfolio and some only invest in mining companies. A fund may be more or less volatile than gold itself, depending on how it's structured and managed. A fund prospectus should always be studied carefully to learn the specifics of your fund's operating objectives and philosophy.

- ETF's (exchange traded funds) are one of my favorite vehicles for trading gold but this comes with a caveat. With any type of “paper gold” there is no absolute guarantee that your fund or manager ACTUALLY HOLDS the gold they're supposed to own. They may hold futures contracts, warehouse receipts, or some other contractual arrangement but, when the chips are down, do they really have the gold? They may not. And worse, they may not be able to get their hands on it in a true global panic. But, does it matter if they don't have it IF you can still sell your ETF shares and get your money out? These are questions that, for now anyway, I don't worry too much about myself. I figure the ETF's are safe enough for my purposes and assume they'll continue to trade and honor their commitments to shareholders. I like to use GLD and especially its double-leveraged cousin, DGP, for short-term trading in my personal account. I can buy and sell in an instant while keeping the transaction costs to a bare minimum.

In conclusion, once you've decided that owning gold is right for you, there is a relatively large number of factors to sort through before deciding how you should own it, in what amounts, and which vehicles might best meet your personal objectives. I've tried to provide you with what I believe are some of the most serious considerations to base your decisions upon. You, of course, must use your own judgment to determine which factors are most important to you.

Owning gold in any of its physical forms has a definite comfort factor that cannot be duplicated with any piece of paper. There are many reasons why gold has been coveted for much of recorded history and, when you hold it in your hands, gold immediately begins to tell you that story in a way the written word cannot communicate. By all means, diversify your approach to owning gold. But don't miss out on the great intangible rewards of owning it in several of its tangible forms. Hold some in your hand, gaze upon it, and you'll see exactly what I mean.

By David Haas

In my consulting practice, I work with individuals, business owners, and professionals.  I assist business owners and professionals in several critical areas ranging from business start-up, marketing, operational challenges, employee retention, and strategic planning to personal asset protection, financial, and retirement income planning.  Often, these areas relate and need to be integrated to work most effectively.  I also assist business owners in developing exit-strategies that enable them to maximize the value of their business interests and preserve their lifestyle in retirement.  For individuals, I primarily focus on tax reduction, financial, and retirement income planning.

© 2008 David Haas, Consultant

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