Mar

12

a penny beginning to meltWhy would people hold hard currency when they can get interest on it or melt it down? Why would governments continue to issue coins with metal content values higher than the denomination values? What is the theoretical probability of that? Yet it occurs in the real world where a penny has twice it value in copper and recent dimes are worth slightly more than their denomination.

The other interesting aspect of this is when numismatic value is increased by melt down events. An increase in scarcity of certain lower mintage dates that would be discovered only as collectors figure out that not so many coins from a certain date still exist.

From a paper by Drs. Espen Gaarder Haug and John Stevenson:

All physical monies with face values contain embedded options. By being aware of these options, more precise valuations of coins and paper money can be made. Some of the most commonly circulating coins in the USA (and also in the UK) have gone from having their embedded option deep-in-the-money to at-the-money, then to deep-out-of-the-money, and then returning to deep-in- the-money. The value of the optionality has been high. Because the central banks and commercial banks are selling such coins at a xed price, equal to the face value, the price and face value of such coins will only be the same when the option element is deep-in-the-money. When the option element moves towards at-the-money or out-of-the-money, arbitrage opportunities arise. Since governments are not adjusting the face values, they have to reduce the value of the coin for example, by stopping the circulation of such coins by other means or by taking legal action against the exporting and melting of coins.

Gene Gard replies:

a nickelI have thought about this a lot, and there is a little more to the interesting optionality of pennies and nickels…

Of course, the theoretical floor to a coin's value is max (face, metal value). In great inflationary times, the metal value will greatly exceed the face value of the coin. But here's the interesting part– if holding the coin in deflationary times, the face value increases, its purchasing power even as the metal value plummets in nominal terms.

Two implications– first, even though you don't get interest payments on your money, if you bought with the metal value "at the money" you are some earning real return in all cases unless the purchasing power of the dollar remains absolutely stagnant. Second, because of the previous point, you're not just getting a free call option on the metal value, you're really getting a free straddle– or in other words, a free "inflation vol call option." The worse inflation or deflation gets, the better off you are. And it's the same investment– no adjustment is required for inflation or deflation. Look back at what happened to TIPS breakevens toward the end of '08 beginning of '09 when the deflation bulls were winning!

Nickels are better than pennies from a storability perspective — nickels are 1 cent/gram and pennies are .4 cents per gram, though pennies are much more in the money right now according to coinflation.com. I haven't decided if I'm buying a truckload of pennies or nickels at this point.


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2 Comments so far

  1. Simple Cms Forex Tactics To Create Immediate Profits From Forex Trading | Forex-Currency Trader on March 13, 2010 5:16 am

    […] The Melt Down Value of Coins, from Pitt T. Maner III : Daily Speculations […]

  2. Michael Arvay on March 13, 2010 12:39 pm

    According to the US Treasury, (http://www.ustreas.gov/education/faq/coins/production.shtml) a coin will typically last 30 years or longer in circulation. 1982 was the last time that cents were made of an alloy of 95% copper 5% zinc. Today’s cents are a copper coated zinc disc with the same design. Other than a few years during WWII, nickels are of the same composition today that they have always been.

    Copper cents may be further in the money, but there are “mining” costs. A forum which focuses on this investment, called realcent (http://realcent.forumco.com) has a large membership and wide samples from the cent-searching members show that the typical circulation percentage of old to new cents is about 22%. There is also a thriving market at the forum where members buy, sell, and trade with their copper cents. The typical price being around 1.4 x face value. So, the mining costs are easily calculated, and a bid/ask spread is evident with a bit of searching.

    Nickels can be ordered from your local branch and involve only the cost of transportation and storage. No mining costs. However, there is no current market for nickels as anyone can just get them from the bank. There is no bid, other than face value.

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