Why Investing In Precious Metals Is More Risky Than You Think

gold coins

Increasing worry about U.S. debt and deficits, low interest rates, the declining value of the U.S. dollar, and the threat of inflation have made alternative asset classes like precious metals more interesting to the average investor. Gold prices rose to a high of $1577 an ounce on May 2. Silver traded at nearly $50 a few days earlier.

Unfortunately, those gains didn’t last. After hitting its high on April 25, the price of silver plunged all the way to $33 per ounce on Friday. Silver lost a third of its value in two weeks. As most commodities prices slid in response to worries about the economy and a weaker dollar, gold fell 5 per cent to $1,495 per ounce. Since then,  silver bounced back to more than $38 and gold to more than $1,500.

Investors have a tendency to blindly pile into asset classes that are soaring in value. This occurred with technology stocks during the dot.com bubble, it happened with housing during the housing bubble, and now the risk seems to be in precious metals.

Meanwhile, despite the recent volatility in gold and silver prices, commodity futures brokers still seem to be encouraging even small investors to trade contracts tied to these metals. Consider this commercial from Lind Waldock, a subsidiary of MF Global, that is still airing on CNBC:

“Stocks aren’t the only game in town,” a young woman tells a companion. “I trade commodities.” “What do I know about pork bellies?” he asks. “Trade what you know,” she replies. “You know about gold, right? Crude oil? With commodities, you don’t have to worry about stuff like PE ratios and CEO scandals.”

There are other ways to invest in metals. For instance, investors can buy shares in an exchange-traded fund (ETF) that mimics the movements of futures contracts. ETFs are bought and sold as easily stocks. Investors can put their money in a mutual fund composed of metals and mining companies’ stock, or they can buy shares in the companies themselves.

It’s also possible to simply buy gold and silver to take advantage of price swings. In a CNBC report April 15 from the Santa Clara Coin Show, one of the largest gatherings of its kind, a dealer spoke of an attendee who bought coins from one dealer and sold them later that day to another dealer at a profit based on the day’s market price change.

There is no shortage of commercials for businesses selling gold and silver coins. The implication is that gold and silver are low-risk, uncomplicated investments. Perhaps you don’t have to worry about price-to-earnings ratios, as Lind Waldock suggests. But investors should worry about CEO scandals.

There are volumes written about the complex considerations when trading commodities, such as correlation to currencies and storage costs. There also are pricing phenomena known as contango — when the futures price is greater than the expected spot price, and backwardation — when the futures price is less than the expected spot price. Other risks include third-world country mining laws and margin requirements — the minimum amount of cash held in a brokerage account to trade a futures contract. Many attribute silver’s precipitous decline to changes in margin requirements. Once you have mastered these topics, perhaps you will be ready to play the metals markets.

This post originally appeared at The Fiscal Times.