Gold Coins and the Pitfalls Investors Should Avoid

Buying gold coins can be a minefield. Here's how to avoid some common mistakes...

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ACCORDING TO the infomercials and radio-talk-show hosts, buying Gold Coins is a slam-dunk strategy for lasting wealth, writes Larry Spears for Money Morning.

Many people are on board. Just last month, for instance, US Mint buyers ordered 107,000 ounces of bullion Gold Eagles – the third-best May in the series' 25-year history.

And this soaring interest in yellow-metal coinage isn't limited to the US market. Take India, where the State Bank of Travancore announced in late April that a program to sell Gold Coins through five of its branches would be expanded to 60 branches in a single months' time. In fact, as one bullion-dealer executive said in reference to India's fifth-largest city: "In Chennai, even the poor buy [some] gold."

So does this mean you should run out and stock up on Gold Coins? 

Not necessarily.

In fact, I'm going to let you in on a secret: If you're looking at Gold Coins as a true "investment," there's only one kind to consider.

The rest are a waste of your time.

Here's a rule of thumb that will make things simple: If you're an investor looking to bolster your portfolio with a modest helping of "hard assets," there's really only one category of Gold Coins to consider.

I'm talking about bullion-based Gold Coins.

Other than that, you can generally find better places for your investment Dollars.

The reason is simple: Due to the costs of minting and marketing, even the most basic of bullion coins carry a markup - a premium over the price of gold itself. 

With bullion-based coins, this markup is generally fairly modest - from 3% to 6% above the Spot Gold Price (though during periods of heated demand, coin premiums can approach - and sometimes even exceed - 25% or even 30%).

But you move away from bullion-based coins – and into the realm of rare or collectible coins – the markups become even more pronounced. 

Once that happens, gold-coin values become almost entirely divorced from the price of gold itself. Instead, they're determined by subjective measures like scarcity, design, condition, and quality. That last valuation variable is especially subjective, since grading standards vary widely and appraisals can differ depending on which "expert" is evaluating a given coin.

Then there's the "liquidity" issue: Gold Coins can also be more difficult to sell than physical gold - particularly when it comes to very rare coins. And with some "collector" coins, investors are often chagrined to discover that there's virtually no secondary demand at all - making it almost impossible to sell them, let alone recouping one's investment.

Given these insights, if you still want to buy Gold Coins, you need to understand two things:

• Are you an "investor" or a "collector?"
• And do you understand the difference between "price" and "value?"

The most important step that you need to take is to determine just why, exactly, you wish to buy the Gold Coins in the first place. 

Are you looking to buy them strictly as an investment - a hard-asset addition to a portfolio that's otherwise composed of stocks, bonds, funds and other such "intangible" assets? Or are you more likely to become a collector?

There's no wrong decision, but you do need to know - because that decision should determine just what kind of coins you are willing to buy.

If you think the coin designs are beautiful, enjoy knowing about their designers and the history of the images depicted, and love how it feels to hold and look at them, then you're probably more of a collector than an investor. That means you'll want to bone up on minting standards, grading, rarity, the completion of coin "sets," and display methods before you begin purchasing.

But if you're trying to establish a hard-asset reserve against the next financial Armageddon - or want to be able to sell at a profit next month or next year - then you are playing in our ballpark and are definitely an investor.

And means you should target the basic bullion coins. 

Now that you understand your objective, you need to do one more thing before you can actually go coin shopping.

You have to understand the difference between coin's "price" and its "value." 

The "price" of a coin is the amount it would cost you to buy it on the open market - once again based on such subjective elements as type, grade, rarity and dealer mark-up. Although prices can vary from dealer to dealer, a good guide to these "retail" coin prices is the "Red Book" (more properly known as "A Guide Book of United States Coins.")

You should probably get a copy (or give it a look at your local library) if you plan to do much trading in US coins.

The "value" of a coin is the amount you can sell it for. That's typically less than the price you actually paid for it and is probably even less than what it would cost you to replace it.

In fact, this difference between "value" and "price" is often well in excess of the original mark-up. Dealers usually offer 75% to 85% of the current "price" for bullion coins, and sometimes as little as half of the price of certain collectible coins. These "wholesale" coin values are reported in what's known as the "Blue Book," and you should probably review a copy of it before you start selling your coins. 

Remember, however, that "Red Book" and "Blue Book" quotes can become quite quickly become out of date, since both retail and wholesale coin prices may change rapidly in periods of severe metals-market volatility - like those we've seen already this year.

It's extremely important to be fully aware of the difference between coin prices and values so you can accurately judge the worth of your holdings. When you buy coins, this differential means you start out with an immediate loss - one that could require a sizable price move in spot gold prices just to get you even. Don't mislead yourself by over-valuing your holdings based on what you paid for them.

But remember: Always insure your holdings based on their price, since that's what it would cost you to replace them. 

Furthermore, always take delivery of the coins you buy – and then store them in a safe place, such as a bank deposit box – rather than letting the dealer or mint hold them for you in a vault. 

Otherwise, you could wind up with nothing but a worthless deposit receipt if the company goes out of business, or is the victim of foul play.

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