E-gold: fool’s gold or a smart investment?

May 2, 2008 - 3:27pm | Articles | Payment systems |

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Goldbugs have a so-so long-term historical record, but with gold prices soaring and the greenback steadily sinking, it's certainly tempting to give the precious metal a closer look. Or better yet, perhaps it is time to jump on the e-gold bandwagon, like those savvy guys in the discussion forums?

Not so fast; let's quickly review what e-gold is and how it works first. E-gold.com is 100% backed by real gold. That means when you have a balance, you own physical gold, and can even have it shipped to you for a charge (32 troy ounce minimum). Bad news is, the company is located in Nevis, Lesser Antilles, and thus fall largely outside the realm of U.S. or European law.

This means you lack certain legal safeguards, notably no recourse in case of fraud and e-gold has been in legal trouble with U.S. authorities for alleged money laundering and other charges. On the other hand, the company has been in business since 1996 with more than five million user accounts and some 80 million USD in physical assets.

So, let's say you've weighed the pros and cons carefully and decide to give e-gold a shot. How do you fare when gold prices overall is spiking, like it is right now? And is there a connection between gold prices and e-gold business activity?

The latter question is obvious: e-gold is doing brisk business with a rapid growth in user accounts (www.e-gold.com/stats.html), from 1 million in 2003 to 5 million in March 2008. As you can see in the chart below, this coincides nicely with the rapid surge seen in the past five years. In 2003, gold hovered in the mid-300 to sub-400 range. Since then, gold prices have almost tripled and the number of e-gold accounts quintupled.

However, there appears to be something of a decline in activity and gold volume. Reliable historical data is hard to come by and e-gold has not responded to our inquiries beyond pointing to their daily statistics page, but based on Wikipedia and earlier articles on e-gold, the total gold supply appears to have decreased from some 3,500 kg to 2,500 kg, and the daily transactions from the 50,000-70,000 range to the 15,000-20,000 range.

Furthermore, it is noteworthy that e-gold's legal woes last year appears to have had no impact whatsoever on the global gold price. The World Gold Council estimates the global gold supply to just south of 4,000 tons, but bear in mind that a lot of the other gold gets tied up in jewelry, dental fillings, electronics and other largely non-liquid forms that are unlikely to re-enter the market anytime soon. Thus, even though e-gold is hardly a big gorilla with its single-digit holding, one might expect some kind of reaction when the boat starts rocking.

Despite that, when the US government cracked down on e-gold on April 27, 2007 with indictments and dozens of sizable accounts being forced to shut down, there was not the slightest blip on the market radar. In fact, the day following the indictment was among the calmest all month.

Was any potential impact counter-acted by some other upheaval that may make gold prices more volatile? Not really; in fact, it was a decidedly ho-hum week following the indictment across the board, with the Dow Jones daily high/low fluctuation rarely breaking the 200-point span.

So why the increase in user accounts? Critics may point to the rise of phishing scams, identity theft, ponzi schemes and other shady online activities as a part of the equation. E-gold is the exchange of choice for many of these characters, primarily due to the liquidity and anonymity. As the scams rise, so should the e-gold activity, the argument goes.

But the bigger part of this is asset protection, of course. When the dollar is down and inflation rears its ugly head, gold always gains a certain luster. But why e-gold instead of say a precious metals mutual fund or more traditional bullion exchange markets? This brings us to the other, perhaps more interesting question, of how e-gold investors fare compared to other forms of gold investment.

Since you own actual gold with e-gold, the daily market price is it. If you bought 6 ounces of gold at $500 a couple years ago, you now have some 6 x $1000 in your account, just like you would if you had bought the same gold in a local store and stashed it in the bank vault or under the mattress. This part is fairly straightforward, making costs the main differentiator.

Indeed, e-gold has certain fees attached to it, depending on the amounts involved. Small transactions are subject to 5% plus 0.0002 AUG, while larger quantities see a percentual decrease to a flat 0.05 AUG for the largest transactions (receiving party). There's also a 1% annual fee for account maintenance for all members.

Compare this to Vanguard Precious Metals and Mining Fund (VGPMX), for example. This fairly typical fund has an expense ratio of just 0.35% per year. Fidelity's Select Gold Portfolio (FSAGX) has an expense ratio of 0.9%.

On the other hand, these funds aren't pure gold funds, but also invest in the industry as a whole with exploration, processing and other aspects as part of the package. Average annual total return for that past five years have been in the neighborhood of 30-35%, keeping roughly in line with the dramatic surge in gold prices, however.

Other online Gold exchanges like http://www.goldmoney.com/ work similarly to currency exchanges, buying and selling at slightly different prices, where the spread is the primary fee collection function. These fees vary quite a bit, and may be hybrids; the GoldMoney example above has a flat 1/10 gram of gold per month ($3.19 at writing), 0.24% storage fee per year, plus a spread of some $10-35 per ounce, depending on quantity.

Finally, there's the old-school method; heading down to a brick-and-mortar store to browse for coins and the like. In that scenario you're paying for the other guy's rent, staff, profit margin etc., plus you have to figure out safe storage yourself. But once you've left the store, the gold is in your possession with no further fees, risk of hackers or anything of the sort.

In comparing these options, the biggest determinants rest on two factors: your need for flexibility vs. overall returns, and your personal comfort level.

E-gold has the obvious benefit of extremely high liquidity on a global scale, something the mutual funds and physical bullion lacks -- you can transfer funds instantly, when you want, where you want. This function is shared by some other online Gold exchanges, enabling instant account-to-account transfers.

If total return and low costs are your main concerns, precious metal funds may be a wise choice. Moving money in and out will take a couple days and the taxman will definitely be aware of your dealings. But if you intend to park money in a long-term investment, the difference in fees grows increasingly noticeable, especially since you'd in effect be paying for a level of flexibility you really have no need for with an online gold exchange.

One benefit of online gold exchanges vs. mutual funds and bullion is minimum investment. E-gold and others have no problem handling small transactions, whereas funds often require several thousand dollars up front.

Finally, if you're not overly concerned about global liquidity, there's something to be said for the peace of mind of having a fistful of actual gold coins safely locked up at your local bank versus a virtual account on the other side of the globe, with no guarantees or protection in case a clever hacker manages to get his hands on your password. Ultimately, what good is wealth if it causes you to lie awake worrying about it?

Matt Danielsson, freelancer of Ecommerce Journal