Sometimes I’m asked why I buy old gold coins instead of gold bullion bars or modern bullion coins. For me, it all comes down to optionality. Optionality refers to the option-like attribute possessed by certain investments.
A call option, also sometimes called a warrant, is the right – but not the obligation – to purchase an underlying security at a predetermined price (the strike price) until the option’s expiration. Basically, a call option gives the buyer levered exposure to the underlying security via a fixed, upfront investment known as the premium. The premium is the purchase price of the option.
This might seem very esoteric, but I guarantee you that it is one of the most powerful concepts in the investment universe. Optionality is an idea that is regularly underestimated in the financial community – to the continual benefit of long term investors in the know.
Stocks are perhaps one of the best examples of optionality in action. The stock of a company that is not profitable today still has a market value above zero. This is because the stock does not expire (unless the company goes bankrupt), giving the owner a perpetual call option on any future earnings from the underlying company.
Regardless of whether those future earnings occur next year or ten years from now, the fact that the stock holder will benefit from these potential future earnings gives the stock value today. This concept of optionality also applies to some investments other than just stocks – for example, antique gold coins.
Years ago when I still lived in Boston, I used to frequent a coin shop called J.J. Teaparty in the financial district. I would peruse the available offerings – usually a mix of gold bullion and collector’s (numismatic) gold coins. When given the choice, I always bought 19th and early 20th century European fractional gold coins. These were pieces that actually circulated when the world still operated under the gold standard.
I usually paid about $10 over the spot price of gold per coin. Because each gold coin contained about 1/5 of a troy ounce of pure gold, the total premium usually amounted to around $50 per ounce. At the time, gold was trading around $500 a troy ounce. So the premium for these 100 year old coins was usually around 10% of spot gold, versus 2% or 3% for modern bullion.
The obvious question is why would I willingly pay more for the same amount of gold? The answer is because that extra $35 or $40 premium over bullion also bought me a perpetual call option on the potential numismatic value of those fractional European gold coins. Sure, the coins were minted by the million and are still relatively common. That is why the additional premium over straight gold bullion was so low.
But in exchange for such a minuscule amount of extra money, I received an entirely new vector for future returns. European fractional gold coins are sensitive not only to the price of gold, but also to changes in their value to collectors. They are an overlooked investment double play in a world that rarely gives anything away for free.
Another example is a 16th century Persian gold 1/2 mithqal that I’m considering purchasing. The price is $110 and the bullion value is around $76.50. This gives us a premium over bullion value of about 44%.
Now this might seem high at first, but this is no common 20th century coin. This 450 year old gold 1/2 mithqal has wonderfully bold Persian calligraphy and a lot of eye appeal. No, the coin isn’t perfect – as evidenced by its somewhat flat strike. If it didn’t have this defect, it would be a much, much more expensive coin.
In any case, I would happily pay an extra $33.50 over bullion value for a very collectible 16th century Persian gold coin in the hopes that its numismatic value increases in the future. The numismatic optionality of this coin seems like a very good risk-reward ratio to me at the quoted price.
And, as I mentioned before, optionality turbo-charges your potential returns. With the Persian gold coin above, if the numismatic premium on the coin increases from 44% to 100% you experience a return of 39% – all without the price of gold moving one dollar. But if the price of gold doubles and the numismatic premium increase to 100% simultaneously, then the multiplicative effect magnifies your return to 178%!
This is the power of optionality in action. So yes, if given the choice between plain bullion and old gold coins, I will almost always choose the undervalued optionality offered by the latter.
