Gold is a wonderful substance. Technically a mineral, but it is so much more than a mere mineral. Since time immemorial, it has been the symbol of wealth and power. It has caused the rise and fall of empires. Even in the modern world, it adorns the rich and the powerful. It is universally accepted in exchanges between the most hostile of governments. Over 4,500 metric tons of gold sits at Fort Knox, underscoring the financial system of the United States, although there are those who say some of it, or a substantial portion of it, has been stolen. Some say it has magical properties.
So, if it is as important as it appears, shouldn’t it make an ideal investment? Or does the allure of gold cheat those who seek to possess it into buying something that is not as valuable as it might at first appear?
Volumes could be written on this issue. But the unfortunate reality is that there is a seedier side to gold investing that can trap the unwary. Not all gold is the same. In many instances, the value of gold comes from its weight. A newer $20 gold bullion coin weighs about .9675 ounces and is worth $4,295.00 if it is purchased from a dealer. That same coin, if a private individual were to sell it, might net them $3,850.00 or so. But the gold’s value is tied to its weight and the market price of gold at a certain time or place.
But some coins—not bullion coins, but other coins from history—have a value that far exceeds their weight in gold. This is called “numismatic” value, and it focuses on characteristics like, rarity, historic significance, condition, and desirability. A 1933 Saint-Gaudens Double Eagle $20 gold coin sold at auction in 2021 for $18.9 million. The weight of that coin was slightly heavier, which would have increased its intrinsic value to around $5,000, but $5,0000 is a long way from $18.9 million. A Spanish eight-escudo gold coin typically weighs less than an ounce but sells for $15,000 or more. All these coins are far more valuable than their weight in gold because of their rarity, their condition, and their history.
Then there is gold that comes in other forms: gold bars, jewelry, art, etc. All these items of gold have some value, depending on their weight, workmanship, etc. There is gold recently removed from mines or panned from rivers. And there is the value of the stock of mining companies that recover gold.
So, while gold may often be a valuable and important part of a portfolio, it also offers an opportunity for fraudsters and criminals to claim a numismatic value far more than what a coin might be worth. More mundane gold transactions also carry with them substantial financial risks that an unwitting or trusting investor may understand. Also, there is no rule that requires the price of gold to always go up. Between 1980 and 1982, gold fell in value by 58%; in 2008, it fell by 30%; and between 2013 and 2015, it fell by 39%.
Common Pitfalls in Gold Investing.
The Internal Revenue Service allows people to purchase gold as part of a 401(k) investment. Internal Revenue Code (IRC) Section 408 imposes several requirements for using gold in a 401(k) plan. First, the gold must be of 99.5% purity, except for American Eagle bullion coins which have a lower level of purity. Second, only gold bullion can be maintained in a 401(k) plan—no coins with numismatic value may be held. Third, and perhaps most importantly, the gold bullion in the 401(k) plan must be held by an approved bank or custodian. This means that the investor is not permitted to keep the gold bullion at home or even in a bank safety deposit box.[1]
[1] These rules, of course, only apply to 401(k) plans. Investors who are not seeking the tax-deferred benefits of a 401(k) are free to handle their gold as they see fit.
But the IRS imposes minimal duties on the custodian of the gold. In essence their legal duties are only to ensure that the gold complies with IRS purity requirements and maintain ownership and physical control of the gold. While they are to ensure the safety of the gold within their possession, they have no other legal duty to the investor, at least as far as the IRS is concerned.
The Two Companies Involved in IRA Gold Investments.
The companies that sell gold bullion coins and bars are not the companies that hold the gold once it has been purchased. These companies buy gold at a wholesale price, and they sell gold at a retail price, but they are not responsible for holding the gold for the consumer. So, there are two entities the investor is dealing with, the gold seller and the custodial company. The company who sells the gold completes its part of the deal when the gold is sold. The custodian takes over from there and holds the gold. But the structure of a bad investment already exists.
At the beginning of the transaction, the investor purchases gold at a retail price. This is not like the purchase of a stock where market forces set a certain price for both buyers and sellers. It is more like buying something from a store. To remain in business, a company must purchase an item at a lower price—the wholesale price—and sell it at a higher price—the retail price. The margin between those two prices pays for the store’s overhead and profit.
How much is this margin between the whole sale and retail price for most gold companies? Usually, ten to fifteen percent. This means that when an investor purchases gold from a company and stores it with a custodian, his investment has already lost ten percent of its value, not counting storage fees.
There is another oddity to the way gold is purchased and sold in the IRA context. Gold is a commodity, and like any other commodity, there are exchanges where it can be bought and sold. In the United States, the most used exchange is The Commodities Exchange (COMEX). COMEX, however, does not deal with retail purchasers of gold. To trade on that exchange, one must open an account with a commodities broker. These brokers should be members of the National Futures Association (NFA) and are regulated by the Commodities Futures Trading Commission (CFTC). Traders seeking a return from investment in gold often use COMEX (or their account tied to COMEX) to buy and sell gold futures often making large amounts of money. This is very different from the purchase of gold at retail prices for investment purposes.[2]
[2] Investing in any type of “future” involves entering into contract to buy or sell a commodity at a certain price sometime in the future. Sudden changes in the price of the commodity can greatly benefit investors, or it can destroy the investment. Extreme caution should be used in making any futures investment.
The TV Sales Pitch.
For the companies selling gold, there is usually intense pressure on employees to sell as much gold as they can. So, an elderly individual may come across a commercial on the television stating or implying that an investment in gold is the key to future success, maybe even survival. When he responds to the commercial by calling the 800 number on the screen, he finds himself talking to someone who is trained to make the sale. The salesman will not know the financial circumstances of the caller and probably doesn’t even care. The salesman’s goal is simply to sell as much gold as possible as quickly as possible.
But there is an immediate problem, the gold placed in the investors account can only be sold at a ten to fifteen percent discount. This means that if someone purchases $100,000 worth of gold bullion coins, his account will only have a value of $85,000 to $90,000. Just by making the purchase, the investor has already lost between $10,000 and $15,000. For the investor to break even in the first year, the price of gold would have to increase by more than ten to fifteen percent. Stated another way, if gold increases in value by twenty percent in a year, the investor will have an increase of an anemic five to ten percent.
Unfortunately, this problem is never explained to the investor. We have seen cases where investors have been told they lost money even when the price of gold has increased by thirty or forty percent.
But the advertisements that appear on TV and the sales pitch of the salesmen at the gold company stress only the upside of gold investment.
Is There Anything the Can be Done?
For many people unfamiliar with the business of gold investing, which unfortunately includes almost all people who invest in gold IRAs, the investment in gold will be a bad investment. A financial loss, however, does not mean that there was a violation of the law, nor does it mean there is an automatic right of recovery. To determine if anything can be done, I recommend retaining a lawyer familiar with this area of practice. Some of the items that should be investigated are:
- The age, experience, and background of the person making the investment?
- How did the initial contact between the gold company and the person making the investment occur?
- What promises, statements, or representations were made?
- Was there a conflict of interest by the company selling the gold?
- What is the relationship between the company selling the gold and the company holding the gold?
Every case is different, and we may need a lot more details before determining what can be done. It is also a good idea to keep any documents, letters, or emails the person making the investment received. If there are any questions about what happened, we can be reached by email at Dboyle@boylejasari.com or by phone at (771) 217-2400.
