-- Posted 29 September, 2010 | | Discuss This Article - Comments:

The 1099 reform in the health care bill passed by Congress and signed by the President has turned the physical gold market upside down.  Under the new law, gold buyers and sellers will have to fill out a 1099 on each side of the transaction if the sales price is greater than $600.  As a result, many investors who have been buying gold as an anonymous way to protect their wealth are now feeling the heat.

The Economics of the 1099

Just months after passage, the Senate has already moved to remove the 1099 requirement from the health care bill in an effort to reduce transaction and accounting costs for small businesses.  With many companies processing far larger orders than $600 on a near daily basis, it is certain that new regulation will prove to be time consuming and costly. 

Just today, the Wall Street Journal reported that in 2008, regulations cost businesses more than $1.7 trillion.  This new regulation, one which virtually no business can avoid, will only add billions of dollars in additional regulation costs to an already burdened American economy.

However, what really matters here is that this new provision will be far more devastating to local gold and silver suppliers.  These small businesses rely on volume to make a profit, with the spread between buy and sell prices often little more than a few percentage points.  For a small coin shop to cover rent, utilities and other fixed expenses of $5,000 per month, it would have to sell as much as $100,000 in gold and silver to pay the bills.  Add on regulatory costs, the time required to fill out each 1099, and the drop in investment after the bill passes, and what you have is an industry that has to sell even more product as its buyers run away scared.

Supply Shock

When the legislation takes full effect, demand for light coins and junk will explode as buyers and sellers look for creative ways to avoid 1099 paperwork.  Silver coins will very easily fit under the $600 threshold, while only .25 and .10 ounce slivers of gold will be small enough to fly under the radar.  As a result, the physical metals market will see a huge increase in demand for lightweight bullion, but at the present time, these products make up a very small portion of all the bullion sold!

This is where the disconnect will begin.  With very few companies interested in producing small physical metal products, and many investors regulated into purchasing them, premiums on small amounts of silver and gold will skyrocket.

How buyers adjust their purchases cannot yet be understood.  Will gold investors swap ¼ ounces of gold for several ounces of silver?  Will the big buyers simply buy lots of 25 silver ounces, hoping to avoid the 1099 cutoff?  Will we see “crisis premiums” as demand far outstrips supply?

Unlike gold, silver is uniquely positioned to benefit here.  Since the dollar price of an ounce of silver is still quite low, demand for gold may rush into silver to a point at which the gold to silver ratio inverts, and silver rises to new historic highs while gold stands flat.  Astute investors would be wise to start stocking up on bullion in modest denominations as demand for these products is soon to explode!

Dr. Jeffrey Lewis

www.silver-coin-investor.com