Should You Add Gold and Silver Coins to Your Portfolio?

Source: Thinkstock

Source: Thinkstock

When most people think of gold and silver investments today, they think of futures contracts, of ETFs such as the SPDR Gold Trust (NYSEARCA:GLD), and the iShares Silver Trust (NYSEARCA:SLV), and of mining companies. However, many precious metal bulls advocate that investors hold some of their precious metals in coin form.

This seems burdensome. First, gold and silver coins need to be purchased. This means finding a dealer, figuring out which coins to buy, and paying a premium to the spot price. Then these coins need to be stored.  Furthermore, they can be lost, stolen, or damaged. None of these issued arise with precious metal ETFs or with mining companies.  Why go through the trouble?

The reason one would go through the trouble of buying gold and silver coins is very much related to why one might invest in gold and silver; gold and silver coins function as insurance against the banking system.

Gold and silver are stores of value, and this value is not based on their interest rate or dividend/earnings yield, which is where bonds and stocks get their value. If you believe that demand will increase for assets that are stores of value, it follows that you are generally bearish on those assets that are valuable only insofar as they pay interest or earn income.

When you buy futures contracts or gold and silver ETFs you are allowing your broker to be a custodian of your precious metals. But at the same time, your broker is net-long of the assets you are bearish of by virtue of being bullish of gold and silver. Given this, it follows that there is inherent counterparty risk in your broker, who may go bankrupt in the event of a bond market decline. Now, theoretically, this shouldn’t be a problem as brokerage houses are supposed to keep their clients’ assets segregated from their own assets, and theoretically if your broker goes bankrupt then your assets should remain unscathed.

However, we know that this isn’t necessarily the case given recent events. Recall the futures broker MF Global absconded with client funds in order to cover its own bad bets on European debt. Now for stock and ETF investors, there is a safe-guard in place. The U.S. government put in place an insurance policy much like the FDIC called SIPC: the Securities Investor Protection Corporation. If your broker goes bankrupt and uses funds from your account to cover their bad bets, then SIPC insurance covers you up to $500,000 per account.

Well, that’s great! Unless you’re rich, all of your funds are protected by SIPC. However, it’s not that simple. Like with any insurance policy, it takes time in order to pay off. If you live off of the money in your brokerage account and your broker takes your assets, you do have recourse through SIPC insurance. But how long will it take before you are actually reimbursed? It could take months, and if you live off of the money in your brokerage account then this could be a major problem. But you will be protected if you have some of your wealth in gold and silver coins.

The banking system can fail us in other scenarios as well. A great example of this was on September 11, 2001. The banks were closed, and if you needed money from your bank or broker, there was nothing you could do. Now, one day isn’t a big deal. However, a terrorist attack, major power outage, or some other black swan event could leave you without access to your assets if they are all in the bank or with your broker. But if you have gold and silver coins this isn’t a problem.

Investors looking to buy gold and silver coins should consider the following advice. First, you want to purchase coins that are easily recognizable. American Silver and Gold Eagles, and Canadian Gold and Silver Maple Leafs are excellent examples of recognizable coins. A silver coin from Kazakhstan might look nice or have a unique quality to it, but most people won’t be able to recognize it for its precious metal value.

Second, avoid numismatic coins and try to buy coins that sell for low premiums over the spot prices of gold and silver. While you can make a lot of money buying numismatic coins, this field requires a completely different mindset, and it is governed by different fundamentals than bullion coins.

Ultimately, while I like the convenience of ETFs and the leverage and upside potential of mining stocks, I think all investors should have at least a small portion of their assets in physical precious metals in order to ensure themselves against the risks mentioned above.

Disclosure: Ben Kramer-Miller owns American Eagles and Canadian Maple Leafs.