The Gold Rush: Don't Get Burned

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Keep Close to the Spot Price

New investors in the yellow metal also need to keep an eye on the spot price of gold to ensure they're not being charged too high a premium for gold coins. It's common these days for dealers to sell gold coins at 8% or 9% above the spot price, and that's not necessarily bad, given the supply constraints for the retail product due to higher demand, says Dave Meger, managing director of metals services at Alaron Trading in Chicago. His firm has had to turn away orders occasionally in recent months when it hasn't received fresh product from the U.S. Mint.

During the fourth quarter of 2008, U.S. consumer demand for gold coins and bars jumped to nearly five times the amount from a year earlier, to 34.8 metric tons, according to the World Gold Council. Between Sept. 15 and early December, Blanchard sold more gold than it had in the prior three years, despite the Mint's 45-day suspension of sales of one-ounce American gold eagle coins after the collapse of Lehman Brothers. Blanchard had to sell "whatever product we could get our hands on"—Canadian maples or South African krugerrands—until supply of American eagles resumed, says Beahm. "At that particular time, nobody really cared what they had as long as they had gold."

To keep the premium they pay over the spot price to a minimum, Meger at Alaron recommends investors buy from one of the four authorized distributors that buy directly from the U.S. Mint. The Mint charges premiums of 3% on one-ounce gold coins, 5% on half-ounce coins, and 7% on quarter-ounce coins when it sells to authorized purchasers, which in turn mark up prices to dealers and individual investors. While Alaron can't buy directly from the Mint, it benefits from having a partnership with a firm that is an authorized purchaser.

Hedging Gold Purchases

Meger also suggests buying from a dealer who is linked to a brokerage firm with a reputable name in the commodities industry and who sells only exchange-approved brands, hallmarked bars, and reputable mint coins.

"We can offer clients the ability to hedge their purchases with options or futures contracts," he says. A buy-and-hold investor who expects to see gold prices pull back in the short term isn't likely to go to the trouble of taking gold out of the warehouse to sell it, but might think it advantageous to hedge his position by selling a futures contract. "It's nice to be able to deal with a brokerage firm that offers you that ability," he says.

Only a few of the 30 or so refiners whose brands are listed on the New York Mercantile Exchange's Web site sell gold bars in retail sizes of one, five, and 10 ounces. Until about a month ago, those smaller retail forms of gold were in short supply, but now that refiners realize they can get significantly higher premiums for them, they are starting to shift resources from jewelry and other industrial fabrication to increase production of the smaller retail forms, says Meger.

When ordering coins from a dealer, it's best to send your money in as quickly as possible, since dealers will only lock in prices once they've received "good funds" in the form of a bank wire transfer or cash. "The price could change from the time you contact us until the funds are good," says Beahm.

Alternatives to Bullion

From a cost perspective, there are far more efficient ways to buy gold than coins or bars, where uncertainty about the size of markups is compounded by shipping costs, says Leonard Kaplan, president of Prospector Asset Management in Evanston, Ill. "The alternatives are so much better and so much safer. You can either buy futures or ETFs. Then you're dealing with regulated industries, known quantities, not Joe Schmo coin dealer who's been around for two weeks," he says.

Gold investors have to pay shipping and storage costs on top of the hefty premiums they're already paying above the spot price. "Is it worth $6,000 to $8,000 on 100 ounces of gold to have it in your hand, and to lose liquidity, and to pay storage? I don't think so," Kaplan says.

Some strategists suggest waiting for a pullback in gold prices, to around $950, before buying more. But $992 may prove to be cheap a few months from now if things break the gold bulls' way. Beahm at Blanchard believes spot gold is poised to reach at least $1,500 by the end of this year, in view of all the liquidity the government is putting into the economy, which will eventually boost inflation.

Right now, the fundamentals look good for gold. But remember that the yellow metal has tripped up smart investors in years past, and will likely do so in the current boom.

Bogoslaw is a reporter for BusinessWeek's Investing channel.