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INTRODUCTION 2
SUMMARY 21
For the BMG Special Report: “How to Invest in Precious Metals" Visit:
www.preciousmetalsinvestinginfo.com
If you examine the facts with an open mind, the commonly held
beliefs and myths discussed here simply do not stand up to scrutiny.
But their very existence makes an investment in precious metals even
more attractive. Why? Because gaining an accurate understanding of
key information before it becomes common knowledge allows an
investor to buy at an effectively discounted price. Once the public
becomes educated about gold and the myths are thoroughly
dispelled, you can be certain that the investment will be fully priced.
Fortunately for bullion investors, that is not the case today.
Closer examination (see Figure 1) shows that gold only surpassed $800 per
ounce on two days in 1980. And the peak monthly average high was
considerably lower, at $675 in January 1980. It’s hard to imagine that many
people actually bought gold on the one day that it was $850 in 1980. The
average annual high was $613 in 1980. One year earlier, in 1979, the average
price was $306 and in 1978 it was $193. For the many investors who bought
gold ahead of the short-term peak, the price held up fairly well throughout
the entire bear market.
4 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
Had investors simply avoided the mania phase and invested two years
earlier, they wouldn’t have experienced any losses. Had they invested when
President Nixon cut the link between gold and the US dollar on August 15,
1971 (Figure 2) they would have purchased gold at $40 per ounce and
enjoyed a 42 percent per year compounded rate of return after inflation –
well surpassing the Dow’s performance.
Another argument often cited to support the thesis that gold is a bad
Gold has
outperformed investment references studies that compare gold to equities using very long
inflation since time periods dating back to the 1700s. The studies conveniently ignore the
1971. Not so the fact that gold was money throughout the majority of that time, and in fact
Dow.
the price was fixed by the government until 1971. They erroneously compare
gold money held in a vault to an investment in stocks. Stocks cannot be
compared to gold when it comes to risk. Virtually all of the stocks that
existed in 1700 no longer exist today, so at some point investors and their
descendants would have lost their entire investment.
BMG SPECIAL REPORT The Six Biggest Myths About Gold – 2010 Update 5
Of the 30 stocks that made up the Dow in 1929, only General Electric and
Of the 30 stocks
that made up the Exxon Mobil still form part of the Dow today. Of the stocks that made up the
Dow in 1929, only Dow in 2000, only 23 are still Dow components today. Honeywell, Citigroup,
three still form part Kodak, SBC Communications, GM, International Paper Company, and Philip
of the Dow today.
Morris have all been removed from the Index. If investors buy stock and that
stock declines to zero, they lose their investment. They can’t simply replace it
with another stock and ignore the loss (which is what the indexes do).
During the current cycle, precious metals have performed exceptionally well,
outperforming all but two of the companies in the Dow 30. Figure 3 shows
the comparative performance of the Dow 30 stocks vs. gold since 2000.
While gold posted a compounded return of 14.1 percent, 22 Dow
components have posted losses.
6 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
If you consider the period from the abandonment of the gold standard in
1971 to date, gold has performed exceptionally well in terms of purchasing
power (Figure 5). In 1971, an average car cost 66 ounces of gold; an average
house cost 703 ounces of gold; and the Dow cost 25 ounces of gold. Today, 66
ounces of gold would buy nearly four cars, 703 ounces of gold would buy
two houses and only 10 ounces of gold would buy the Dow.
It might be more relevant to ask: “Does gold retains its purchasing power
through both inflationary and deflationary periods?” In 1977, an extensive
study by Roy Jastram was published as a book entitled “Golden Constant”.
His work thoroughly analysed the purchasing power of gold in England and
the US from 1560 to 1976, and his research indicated that gold holds its value
remarkably well over time. Gold prices do not chase after commodities, but
rather commodity prices return to the index level of gold over and over
again.
TYPES OF RISK
There are numerous types of risk that may apply to some investments and
not others.
Liquidity Risk
Liquidity risk is associated with the market on which the investment trades.
Financial assets
often contain An investment that can be sold quickly without price concession is
multiple risks – considered liquid. Small unlisted stocks, privately held mortgages and real
liquidity, currency, estate are somewhat illiquid and can be difficult to sell without incurring
default, interest
rate and market significant discounts and costs. Even publicly listed stocks in a broad market
risk. None of these decline can become illiquid, with smaller public companies being vulnerable
risks apply to gold. to no-bid situations. This was evident in 1987 when many mining stocks had
no bids. Gold and silver bullion are traded by members of the London
Bullion Marketing Association 24 hours per day in New York, London,
Zurich, Hong Kong, Tokyo and Sydney. The average daily turnover was
over $18 billion in April 2010. The turnover is the net difference in trades
between the members, while the trading volume is estimated at 7 to 10 times
that amount. Platinum trades in Zurich but no volume or turnover data is
available. As such, the liquidity risk of precious metals is very low, and at
least comparable if not better than traditional publicly traded stocks and
bonds.
8 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
International Risk
Investors can avoid International risk can include both political risk and currency risk. Political
international risk as risk includes issues such as nationalization or confiscation of assets, punitive
gold is portable. tariffs or taxation and punitive regulatory issues. Gold bullion may be
subject to these issues if stored in politically unstable countries, but since
bullion is portable, global investors will seek to store it in stable countries
such as Canada and Switzerland. However, real estate, corporate assets,
foreign bonds and equities and mining concessions are not moveable and
therefore subject to these risks.
Currency risk must also be taken into account when investing. While the
Dow has experienced new highs since 2000 in US dollars, it has not achieved
any gains in strong currencies such as the Canadian dollar or the euro.
Market Risk
Market risk can be Market risk i s exposure to fluctuation s in the aggregate market. Th ese can be
reduced through full influenced by su pply/demand issues, investor sentiment, structural changes
diversification using in the economy and changes in tax laws. All asset classes are subject to
all six asset classes.
market risk in varying degrees. Proper diversification using at least six asset
classes with varying degrees of correlation can minimize overall market risk.
As stocks and bonds have been correlated since 1969, portfolios consisting of
only three financial asset classes are subject to much higher market risk tha n
a portfolio that includes other asset classes such as real estat e, commodities
and precious metals. The proper balance of all asset classes will not only
reduce risk but improve returns.
The traditional
investment pyramid
(Figure 7A) places
precious metals in the
high-risk group, at the
top. But the pyramid
fails to distinguish
actual physical bullion
— which is a low-risk
investment — from
precious metals stocks,
options and futures—
which are high risk
Figure 7B
demonstrates the
precious metals
pyramid. It details the
varying degrees of risk
associated with
different types of
precious metals
investments. Physical
bullion is at the bottom
of this pyramid
because it is the lowest
risk and highest
liquidity.
BMG SPECIAL REPORT The Six Biggest Myths About Gold – 2010 Update 11
Systemic Risk
Only bullion Systemic risk encompasses several factors such as market risk, economic risk,
provides protection inflation risk, default and international risk. Systemic risk can also include
against systemic terrorist attacks, war, oil supply disruptions, a major stock market crash, the
risk.
collapse of a major financial institution or a breakdown of the banking
system. Systemic risk is not diversifiable and will affect all asset classes
including precious metals. However, once any initial liquidation takes place,
precious metals tend to outperform all other asset classes as investors seek
refuge in the traditional safe haven of bullion. During these times precious
metals tend to become the only form of currency that has any value or
liquidity.
Underperformance Risk
It is true that precious metals did not deliver expected returns during the 20-
year period from 1980 to 1999. However, this was attributable to a number of
market distortions that are not likely to be repeated.
Due to the constant increase of global money supply by central banks, one of
Only precious the longest and highest bull markets in stock market history began in 1980
metals bullion and continued until its collapse in 2001. Over that time, investor demand
cannot default, shifted almost entirely to financial assets (stocks and bonds). In addition, oil
cannot deteriorate and other commodities were priced in US dollars, which increased global
and cannot decline demand for dollars. The US dollar benefited from the collapses of currencies
to zero. in Brazil, Japan, Argentina, Mexico, Russia and South East Asia,
strengthening the dollar against all other currencies as well as gold.
The practice of
Some central banks reduced their gold holdings with a great deal of
leasing gold and publicity, while others quietly increased their reserves. Many central banks
mine hedging
contributed to price
weakness.
12 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
leased their gold, which was sold into the marketplace and caused an
artificial supply. The estimates of total leased gold vary, but as much as half
the central bank holdings of 30,190 tonnes may have been leased out.
In the future, this leased gold will have to be repaid or massive defaults will
occur. The aboveground stockpile of one billion ounces of silver held by the
US Mint was sold into the market. The aboveground Strategic Reserve
stockpiles of silver and platinum were also sold into the market.
Figure 8 shows the result. Even with the corrections in 2006 and 2008
precious metals are still in an uptrend that began in March 2002,
outperforming all other asset classes.
M
MEASUREMENT OF RISK
BMG SPECIAL REPORT The Six Biggest Myths About Gold – 2010 Update 13
Standard Deviation
Precious metals Standard deviation is the most commonly used measure of risk. Standard
provide high deviation calculates the total risk or variance associated with the expected
returns at low risk. return. It simply measures how volatile or widely spread an investment’s (or
portfolio’s) returns are from its mean, over a period of time. If monthly or
yearly returns remain fairly close to the mean, then the standard deviation is
small; if returns are widely dispersed from the mean, then the standard
deviation is large.
Comparing the volatility of gold (17 percent) to the entire Dow Jones index
(15 percent) is unfair, but when gold is compared to individual Dow Jones
components, its volatility is less but the performance is higher.
Precious metals place in the upper quadrant of low risk and high returns
while most of the Dow components fall into the lower right-hand quadrant
of low return, high risk.
14 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
Sharpe Ratio
The Sharpe Ratio (risk-adjusted rate of return) was developed by Professor
Precious metals William Sharpe in 1966, and is the most commonly used measure of risk-
have higher Sharpe adjusted return. It measures the amount of excess return the investor is
ratios than most
Dow components. receiving in exchange for the extra volatility assumed in holding a riskier
asset. It is broken down into three components: asset return, risk-free return
and standard deviation of return. After calculating the excess return, the
Sharpe Ratio is obtained by dividing that excess return by the asset’s
standard deviation. This ratio or risk-free rate of return is used to gauge
whether the investor is being properly compensated for the additional risk
incurred by investing in the risky asset. Traditionally, the risk-free rate of
return is the shortest-dated government Treasury bill.
Sortino Ratio
Precious metals
While the Sharpe Ratio is the most famous risk/return measure, others have
have higher been developed. The Sortino Ratio is similar to the Sharpe Ratio, but its
Sortino ratios than denominator focuses solely on downside volatility, not overall volatility. Since
most Dow most investors are only concerned with downside risk, it is a more
components.
meaningful measure in practical terms.
Figure 11 compares the Sortino Ratio for gold, silver and platinum against the
Dow components. When the two tables are compared, you can see that gold,
silver and platinum are even more attractive, since a great deal of the
volatility has been on the upside, while the Dow components have primarily
experienced downside volatility.
16 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
This reasoning has often been used to denigrate the benefits of holding
bullion. In fact, the Bank of England cited this argument as justification for
selling half the country’s gold holdings at the bottom of the market in 1998.
They wanted to make a “safe” investment in US Treasury bills that would
generate interest (Figure 12). They sold their gold at under $300 per ounce,
and then the price of gold tripled while the value of the US dollar lost 30
percent against the British pound. Combine the currency exchange losses
with the lost opportunity cost and the result is several billion in unnecessary
losses that offset any interest income they might have received. The same
goes for bond investors in an inflationary environment. Their “real” or
inflation-adjusted interest rate is negative.
Gold, like currency or any other asset that sits in a vault, will not earn
No asset class interest or dividends. But equally, it will not be at risk. No asset class
generates income generates income unless you give up possession of your money and take the
unless you give
risk of not getting it back. As we have recently seen in the US and the UK,
possession of your
money and take bank deposits are not as safe as commonly believed. Many people think that
the risk of not money deposited in a bank account is held in trust for them. In fact the
getting it back. money deposited into a bank is legally a loan that the bank lends out in order
to make a profit. The money is simply not there, so if there are rumours that
a bank is becoming insolvent, depositors can panic and create a run. They
know they could lose part of their savings. Likewise, when investors
purchase stocks or bonds, they run the risk of losing their capital.
BMG SPECIAL REPORT The Six Biggest Myths About Gold – 2010 Update 17
Investors who need current cash flow during this high inflation period can
liquidate part of their gains in precious metals to generate income. For
example, instead of holding bonds at 4 percent when real inflation is 8
percent, resulting in a real capital loss of 4 percent each year, investors could
liquidate one-half of a gold gain of 10 percent and still have their capital
grow by 5 percent. On an after-tax basis the gold gain would be taxed at a
favourable capital gain rate instead of interest income. In this way the
investor’s capital grows in real terms and they have more after-tax dollars to
spend.
The inflation rate used is the more realistic inflation rate of 8 percent using
the original formula for the calculation of the CPI as calculated by John
Williams www.shadowstats.com/charts_republish#cpi. In making
investment decisions it is critical to accurately determine the true inflation
rate. Misaligning the investment portfolio with real inflation can have
devastating consequences to the investor.
As can be seen from this spreadsheet, the bond principal has eroded from
$1,000,000 to $472,161 after ten years while the purchasing power of the
annual bond interest has declined from $24,000 to $11,332 after tax and
inflation. At high levels of inflation a bond investment becomes a
guaranteed loss of principal and purchasing power instead of a safe secure
investment. What does the investor do during the next ten years to maintain
their lifestyle after taking real inflation into account?
The systematic withdrawal for the BMG BullionFund increases every year to
maintain a constant after–tax, after-inflation amount. Based on an annual
appreciation rate of 10 percent and maintaining a cash flow of $24,000 after
tax and inflation, the systematic withdrawal plan results in the original
principal growing to $1,395,505 after the withdrawals. After inflation the
purchasing power of the remaining principal is still $928,159.
The result is that not only do investors maintain the majority of their original
principal, but they are also able to maintain their cash flow on an after-tax,
after-inflation basis.
Gold, silver and platinum are traded on the currency desks of banks and
brokerage houses, not the commodity desks. As a result, it is clear that the
banks and the brokerages, as well as their clients, think of gold, silver and
platinum as an alternative to paper currencies.
During sharp market declines, mining stocks become correlated to the broad
equity markets rather than the price of bullion. Figure 15 (Page 20) shows the
comparative performance of mining stocks, gold and the Central Fund of
Canada (CEF), a closed-end fund, during the 1987 market crash. As can be
seen from the chart on the next page, mining stocks declined more than
equities even though the price of gold was rising. The exchange-traded
Central Fund behaved like an equity even though it holds bullion.
20 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
A comparison of
bullion to the
larger gold
producers shows
gold has
outperformed
mining stocks
since March 2007.
During the mature phase of a bull market, mining stocks again tend to
Global investors underperform. In the 1970s, Homestake Mining was the largest US miner.
will use bullion as a Figure 16 shows that the stock climbed an impressive 900 percent, but gold
safe haven rather
than speculating in increased by 1,500 percent.
mining stocks.
As the business cycle changes and the world increasingly loses confidence in
fiat currencies and financial assets, some North American investors may
choose to speculate in mining stocks. However, astute global investors
looking to preserve their wealth will not flock to mining stocks as a safe
haven, but rather to bullion itself. As mine production and the grade of gold
available declines while costs, particularly that of diesel, rise, mining profits
will continue to decline. As reserves are not being replaced by the major
producers, their asset base will tend to decline. As a result, bullion is likely to
continue to outperform the major producers.
S
22 The Six Biggest Myths About Gold BMG SPECIAL REPORT– 2010 Update
SUMMARY
As we have seen, the myths about bullion are unfounded. Physical bullion
protects against inflation and has the potential for significant capital
appreciation. Hardly an archaic relic, it is still a low-risk way to preserve
portfolio purchasing power in bull and bear markets. Investors who evaluate
the benefits of physical bullion and take action stand to reap significant
rewards.
On the other hand, investors who continue to believe in these myths will
miss out on the opportunity to add an asset class that truly diversifies any
portfolio and provides superior returns to traditional assets such as stocks
and bonds during uncertain times. As these myths are dispelled and the
price of bullion rises, astute investors will benefit from their foresight in
purchasing bullion at its current undervalued cost before the public at large
becomes fully aware of the benefits and bids up the price. When you
consider that total global financial assets are estimated at over $145 trillion,
but total global aboveground gold, including art, religious artefacts and
jewellery is a modest $5.7 trillion (and aboveground investment grade
bullion is estimated at less than $2 trillion) a massive wealth transfer event is
very likely to occur. Even a 10 percent reallocation to gold could result in a
1,200 percent increase in the price.
Nick Barisheff is President and CEO of Bullion Management Group Inc., a bullion investment
company that provides investors with a cost-effective, convenient way to purchase and store
physical bullion. Widely recognized in North America as a bullion expert, Barisheff is an author,
speaker and financial commentator on bullion and current market trends. For more information
on Bullion Management Group Inc., BMG BullionFund, BMG Gold BullionFund and BMG
BullionBars visit: www.bmgbullion.com 1.888.474.1001
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