Investing in Gold & Silver For Dummies. Paul Mladjenovic
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alt="Bullet"/> Balancing risk against return
The saying goes “no guts, no glory,” and in the world of money and finance, the equivalent is “no risk, no really cool gains.” Risk is part of the world of building and maintaining wealth and seeking financial security. So risk is something you should be aware of so you can minimize your exposure to it while you try to maximize your gains (and income).
In my financial seminars, I spend a lot of time talking about risk because it obviously needs to be dealt with but also because it’s very entwined in the deepest desires of most investors — increasing return. It goes without saying (so I’ll write it down) that the age-old equation in the world of investing is risk versus return. This equation states that if you want a greater return on your investment, you have to tolerate greater risk. If you don’t want greater risk, you have to tolerate a lower rate of return.
The world is full of pitfalls, and precious metals are no different, but keep in mind that precious metals can excel when your other investments don’t. Precious metals guard or hedge against risks that can hurt conventional stocks, bonds, or other fixed-rate vehicles.
Here are some of the risks against which precious metals excel:
Purchasing power risk: As inflation rears its ugly head, this results in higher prices.
Currency crisis: As nations increase their money supply, the long-term result is usually a crisis or even collapse of the currency.
Geopolitical risk: This can range from war to terrorism to international strife.
Systemic financial risks: This is when a crisis occurs due to problems with vehicles such as derivatives.
Counterparty risk: Gold and silver, for example, don’t have counterparty risk, unlike most “paper assets” (such as stocks, bonds, and currencies). I cover this very important point in depth in Chapter 2.
In this chapter, you find out about types of investment risks in the world of precious metals, discover how to minimize your risk when you invest in gold and silver, and get tips on balancing risk versus return.
THE VALUE OF GOLD IN RECENT HISTORY
A good example of the value of, say, gold or silver is when we discuss inflation risk. Throughout history, when inflation raged in an economy (such as Venezuela from 2015 to 2020 or Yugoslavia during 1993–1994), gold and silver held their value while currencies were rapidly losing their value in terms of buying goods and services. Those citizens were able to trade using gold and silver to exchange with goods and services and get that same basket of goods and services when, in terms of the currency, the price was skyrocketing.
Take Zimbabwe during its hyperinflation in 2006–2007. A roll of toilet paper skyrocketed to a price of $145,750. Meanwhile, that same roll of toilet paper was selling for $0.69 in the U.S., and a single ounce of gold could have literally bought a truckload of toilet paper (I guess that gives an entrepreneur a great opportunity to sell toilet paper at a nice profit in Zimbabwe).
In the 1950s, you could have bought a nice man’s wool suit for about $30. However, that same equivalent suit would cost you about $1,000 in 2020. In that case, an ounce of gold in each case would have helped you acquire that same suit with money to spare (in case you also want to buy a pallet of toilet paper!).
At the time of writing this book, the Federal Reserve had printed nearly $10 trillion in dollars in an attempt to mitigate the financial and economic crisis stemming from the global pandemic hitting the U.S. economy in spring 2020. Given that, the risks of inflation increased, which, in turn, give gold and stock investors another reason to add those shiny metals to their portfolio.
Exploring Different Kinds of Risks
Before I make you paranoid about risk, keep in mind that it’s ubiquitous and just a normal part not only in building wealth but also in living life. Heck, just getting out of bed in the morning could pose a problem. Here are the various types of risks you face when you invest in gold and silver (now that you’re out of bed).
Physical risks
By physical risks, I don’t mean that you may hurt your back from picking up precious metals (heavy metal is a different animal altogether). It just means that if you have gold in physical form, you have to understand that having it has risks, as does owning any valuable property. You have to keep it in safekeeping. For some, that means keeping your physical metals (such as gold, silver, and platinum) possessions in a safe-deposit box at the bank. For others, it means keeping them in a secure hiding place at home. For still others, it means getting storage with vendors such as bullion dealers.
You have to decide. Gold as a physical holding means you have to be concerned about the risk of loss or theft. Then there’s the relative risk — what if your relative finds out? Removing some risk always means common sense. After all, if gold hits $3,000 an ounce, I don’t think you should be boasting about your investing skills at the local bar.
Market risks
Another element of market risk can occur when you’re involved in a “thinly traded market.” In other words, there may not be that many buyers and sellers involved. This is also called liquidity risk. This can happen, for example, in futures (covered in Chapter 12). Although futures are usually a liquid market (an adequate pool of buyers and sellers), there may be some aspects of it when it may not be that liquid. Say that you want to sell a futures contract that you recently bought that isn’t an actively traded contract. What if there are no buyers when you want to sell? Your order to sell through the broker may sit there for a long time. The sale price of the contract would drop, and you would lose some gain or even end up with a loss. Be sure to communicate with the broker regarding how active that particular market is.
Another example is the market risk of mining stocks. The stock of mining companies certainly can go up and down like most any other publicly traded stock. Stock investors can sell stock when they see or expect problems with the company. If, for example, you’re considering a gold mining company, the risk to consider is more than just the fact that it’s gold and the commensurate market risks with gold itself. It’s also about the company. Is management doing a good job? Is the company profitable? Are sales increasing? How about their earnings? Do they have too much debt? And so on. Mining stocks are covered in Chapter 7.
Futures exchange risks
What the heck is exchange risk? That sounds odd! Well, it’s not a reference to currency exchange; it’s a reference to the risks that could occur at the exchanges where futures and options are traded. When futures (see Chapter 12) and options (see Chapter 13) are transacted at an exchange, such as at the Chicago Board of Trade (CBOT) or the New York Mercantile Exchange (NYMEX), they are done so under the rules and regulations of the exchange. The exchange can either purposely or accidentally encourage market outcomes by changing the rules