Should You Invest In Gold?
If you tune into conservative talk radio or financial television programming, undoubtedly you have been inundated with advertising to buy gold. With the continued uncertain economic picture, many view gold as a “safe-haven” for their money. Fears about inflation, the strength of the US dollar, and national security provide additional concerns. Certainly with gold still trading at near record highs, the interest in this commodity continues to grow.
To properly analyze if you should hold gold in your investment portfolio, you should consider some additional facts. If the price of gold has risen to record highs, who has been buying gold? The vast majority of buyers have been central banks around the globe. They certainly have incentive to buy gold since it allows them to diversify away from the US dollar and provides an inflationary hedge. In addition to central banks, exchange traded funds and hedge funds have been buying gold as well. This purchasing has inflated the price of gold and caught the attention of most investors.
From an investment perspective, other facts must be considered. Gold does not pay a dividend or provide any cash flow. Profits are based solely on price appreciation driven by supply and demand. Currently demand is very high, and some analysts already believe that production has already peaked.
With gold sitting at record prices, is it a prudent move to buy gold at nearly three times the price it costs to produce? It currently costs about $400 an ounce to produce. If you are not holding gold today, buying gold at record high prices may not be a prudent move.
Prudence aside, the key question is “could gold go higher?” The short answer is “yes”. From an economic perspective, triggers for a massive run-up that would see gold prices rise by hundreds of dollars per ounce include anything from a double dip recession, to escalating deficits or purchases by the Chinese government. This reason alone is enough reason for some investors. They view owning gold as an “insurance policy” for their investments. They assume gold will rise while other asset classes fall and will provide a hedge against their losses. It should be noted however, that while gold serves as a currency hedge for nations, most domestic investors are buying and selling goods in their own currencies so the devaluation of the US dollar has little meaning.
If you decide to purchase gold, in what ways do buyers go about this?
You can buy gold coins or bullion, you can own gold indirectly through exchange traded funds (ETF’s) or stock of mining companies. You can also invest in pooled accounts where your gold is held in vault. There are numerous pros and cons associated with each of these that I will not further outline. An article in The Wall Street Journal did an excellent job outlining the pros and cons in a January 25th article that can be read at this link http://online.wsj.com/article/SB123284319920613125.html.
A question I often receive is “how much of my portfolio should I hold in gold”. Of course each and every individual’s circumstances dictate recommendations. However, it is extremely important to view gold as just another asset class. In that sense, it may provide diversification benefits by “not having all your eggs in one basket” so to speak. However, just as it would be unwise to have allocated your entire portfolio to oil stocks when it appeared oil was going to rise to $200 a barrel, you should be cautious in the percentage of your portfolio you hold in gold. Most experts and financial planners recommend an individual hold no more than five to ten percent of your overall portfolio in commodities.
Some may still ask “if the price of gold is likely to rise, why not hold more? The answer is simple. Just as in 2007 when no one thought the price of a barrel of oil would ever go back below $100 when it was at reaching record highs near $150 (current price is now $80 a barrel, about half of the near record $150 price where it peaked), there are several scenarios that could also cause the price of gold to fall. And since the price has risen to all time highs, it could be steep drop. At the current price, gold prices would only need to fall back to $800 an ounce (which was the price just over a year ago) to cause a 30% decline in value. Yes, you can lose money in gold too.
In fact, historically gold has significantly underperformed the majority of other asset classes over long periods of time. While you may find short-term trading opportunities in gold, the long-term investor would be wise to allocate cautiously towards gold and commodities at these record high prices. If you do make a purchase, make sure you have done your homework and do so with a carefully planned strategy based on your individual plan, not based on fear, emotions, past performance or greed. Purchases of any type that are motivated by these factors almost always end in disaster.
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