(Note: This article was written July 1, 2004 and was originally published on the website http://www.GoldMarketAdvisor.com as an informative article.)

For what it's worth:

I have been curious for a long time about how to buy gold as a commodity.

I opened a commodity trading account and funded it with US$40,000 to start with. Then I bought an ingot and took delivery. Here's the story. Learn from it if you can.

The initial paperwork was a little odd - my own assets are nearly insignificant, but my wife had enough to let them accept us as a client.

Moving the money to Chicago, Illinois, in a timely manner proved to be more complex of a task than we'd initially imagined. We didn't want to write a check, mail it, then wait for it to clear. We elected to move the money by wire. I wanted to lock down the trade at the current spot price if I could.

My wife had some trouble getting to the bank during the time when the bank would allow wire transfers. Since the funds weren't coming from a joint account, I couldn't authorize the wire, my wife had to do it. My wife asked to place an order for the wire transfer, hoping that it would go out the following morning, but was told that she would have to be physically present at that branch of the bank while it went out. This is bad Customer Service on the bank's part (our two other banks don't require us to be there when the wire goes out), and my wife wasn't about to miss work to suit the bank's convenience. In frustration, she asked the teller if she could withdraw US$50,000 in cash, so that we could move it to our joint account (which is in a different bank).

That didn't work either, but it kind of got the teller's attention. While he went to check with his boss, I told my wife that they wouldn't have that kind of cash on hand. Sure enough, if you want cash like that, this particular bank requires that you order it three days ahead of time. We settled for a cashier's check, and hoped that the $POG didn't move significantly against us while we were waiting for the cashier's check to clear.

Twenty minutes later, we were depositing the cashier's check into the joint account, and three business days later (after the funds cleared) I ordered the wire transfer. We put US$50,000 into the joint account, but I only authorized the wire transfer of US$40,000 into the commodities trading account. The additional US$10,000 wouldn't be needed right away and I thought it prudent to keep it available for other/unexpected things for a while.

Funny thing - or maybe not, maybe it's just human nature - as soon as the broker got confirmation from his HQ that the money was actually in the trading account, he suddenly started calling me "Buddy". I don't know, maybe he's been subjected to a lot of folks that talk a good game but don't follow through with what they say they'll do. He was civil enough before funding the account, but his attitude towards me definitely changed once the money was there.

I told him in our initial interview that I wanted to buy a 100 ounce contract, then take delivery. I told him that I would have ALL of the necessary funds in the account before placing the trade, because I refuse to be subject to margin calls. There are two things to note here: taking delivery is uncommon, and trading without trading on margin is uncommon.

The three day delay waiting for the Cashier's Check to clear didn't hurt us, in fact the $POG dropped a little while we were waiting. This made it cheaper for us to buy in. I started watching the spot price even more closely and was 'fishing for a bottom'.

When I figured the price was right, I called the broker and told him I wanted to buy a contract for 100 ounces of gold. He asked me which contract I wanted (there are about eighteen or so available, but it's usually only the two or three with the least amount of time remaining on them that get the majority of the attention). I told him I wanted whatever was cheapest. He indicated that the front-running contract was cheapest, but that it only had three days before Settlement, and that I might have more flexibility if I bought the next contract behind that.

This comment was surely based in the Broker's force of habit. I reminded him that I wasn't interested in speculation, didn't need the time-based flexibility and that I wanted to take delivery. I literally wanted whatever was cheapest. He had to adjust his 'normal operating mode', but he managed that quickly and shortly had placed my order. After that, it wasn't long before the trade was executed and confirmed.

Settlement Day came and went. Settlement is when the brokers on both sides of a trade consult with their clients to see whether the trade is settled with physical goods or with cash.

There are four possible combinations here:

  1. If the Buyer wants to settle with cash and the Seller wants to settle with cash, that's how the trade is settled (which is how probably about 90% of commodities trades are settled).
  2. If the Buyer wants physical goods, and the Seller wants to settle in cash, the Seller's Broker uses cash from their account to purchase the goods in the spot market, then negotiates the logistics of delivering those goods to the Buyer's account.
  3. If the Buyer wants to settle in cash and the Seller wants to deliver physical goods, the Seller's Broker has to sell the goods into the spot market and then moves the cash to the Buyer's account.
  4. If both the Buyer and the Seller want to settle with physical goods, the Brokers make arrangements for the logistics of moving the physical goods from one account to another.

I called my Broker about three days after Settlement Day, and asked why he hadn't contacted me for settlement instructions. He indicated that there was some flexibility in the timing, and that the inquiries didn't actually have to be made on that day, but they shouldn't be made before that day. Besides, tens of thousands of trades take some time to settle, you just can't make that many calls in one day. He'd been waiting to hear from our counterparty. I told him again that my intent was still to take delivery, and that when the counterparty contacted him, that's what he should tell them.

Now here's something interesting. "Taking Delivery" isn't the same thing as "getting physical possession". I can take delivery, then later sell back into the futures market and subsequently have it delivered to the new owner, without ever seeing the physical goods that are involved. It's the brokerage house that gets physical possession - on my account. Actually, the brokerage house probably contracts out for secure storage. They physically store it for me (for a small fee - kind of like rent) and I don't have to see it unless I really want to deal with providing secure storage for the physical goods myself. I don't know what the brokerage house would do if I asked them to "Take Delivery" on a contract for 50,000 gallons of unleaded gasoline. If I owned a gas station, maybe I'd do that.

It is possible to get physical possession of the gold I bought if I want to. Once the 100 ounce ingot is stored on my behalf, I can order the brokerage house to ship it to me. FedEx will send it cross-country from NYC to my doorstep with overnight delivery - if I want to pay for that.

The problem is once I take delivery, they will be reluctant to put it back into the system. Because it's out of their control, they can't tell if someone has substituted a fake of some kind. In theory, it is possible to have the item tested for adequate quality and quantity and then returned into the system (unless the item is perishable?), but in practice that's problematic.

I'd be curious about what's involved, and if I was getting paid to write these things, I'd go ahead and do it for the experience, so I could write it up for you. I don't see it happening in the near future, so at this time, I'm not ready to pay that cost in order to learn that part of it.

Another issue is whether I can store it securely. I probably could, if I wanted to have a safe installed. I'd have to consider the costs versus the long-term value. I don't think there's enough room left over in our safety deposit box (it's full of important papers), so we'd have to rent a bigger box if we wanted to store an ingot at the bank. I think it's cheaper to just leave it in the Brokerage House's secure storage and keep paying them rent.

In closing, I'm happy to say that the $POG has played yo-yo since we bought. It's been above and below, but since we took delivery we aren't so much worried about paper losses or profits. We can chose to sell at a loss if we want to lose on this deal. Or we can take physical possession if it looks like we'll need to hold onto it for a long time (my bet is that I can securely store a 100 ounce ingot for a decade for less money than it would cost me to store it in the Brokerage House's account). Or we can take delivery and I can make jewelry out of it. Or we can leave it where it is for a while and wait for the $POG to go to a place where we are comfortable about selling it.

But the trend is up, the price is up and we're long one ingot.

I hope you can do better than I do!

The Gold Market Advisor.

Copyright © 2004 by Global Investment Opportunities, Inc. - All rights reserved.