Three Reasons to Invest in Gold

Kiplinger's offers three reasons (reasons they say are debatable, risky, and scary) to invest in gold as follows:

• Reason #1. The first reason to own gold -- the debatable one -- is its beneficial effect on your total investment program. Many financial planners and other experts point out that gold can reduce a portfolio's volatility. And it's true that in both inflationary times and times of uncertainty, gold's price tends to rise as prices of most stocks and certain bonds tend to fall-although gold has been sinking, along with just about everything else, in recent weeks. The net effect of gold's historical tendencies is to stabilize a portfolio's value. However, gold can drag down performance over time. For this reason, many advisers do not endorse its use. Russell Wild, a financial planner in Allentown, Pa., puts it this way: "Over the long term, gold has just about kept up with the rate of inflation, but with a lot more volatility." Not very impressive.

• Reason #2. The second reason for buying gold, the risky one, is simply that you think its price will rise substantially. Maybe. But keep in mind that even when gold was trading at about $1,400 an ounce last spring, many analysts were bullish because of all the financial uncertainty. Today the financial situation is much worse, but instead of rising, the price of gold is at less than half its spring peak.

• Reason #3. Then there's the scary reason to own gold: protection from a collapse of the financial system. If this happens, a single gold coin will be worth a wheelbarrow full of currency (think of Germany's Weimar Republic issuing 50-million-Mark bank notes in the 1920s). Unfortunately, we couldn't find any survivalists to interview for this story, but all the experts we contacted had a good laugh when asked about this scenario.

This piece was written October 24. I bet there are far fewer "experts" laughing now than there would have been three months ago.

Anyway, here's their conclusion to the piece:

In the end, none of the three reasons for owning gold carries much weight.

They also offer how to buy gold if you simply MUST have some -- two options:

• The simplest, safest, most efficient way is with an exchange-traded fund, such as iShares Comex Gold Trust (symbol IAU) or Street Tracks Gold Trust (GLD).

• If you want to buy gold for that warm, secure feeling it brings, buy some coins. You can purchase gold American Eagles or Canadian Maple Leafs at close to gold's spot price from a reputable dealer, such as March's Superior Gold Group.

I don't own any gold as of yet and don't really have any intentions of buying any (though I must admit that the current financial crisis has led me to do a bit more investigating of the issue.) How about you? Anyone out there own gold? How do you own it (coins? ETFs?) What percentage of your portfolio does it make up?

Update: more food for thought -- here's a piece saying gold isn't performing as expected.

Comments

[F2O]

I own a few gold coins, but not so much for the investment. Since I have other coins in my collection, I thought would be neat to have a couple old gold ones. I got them a good 5 -6 years ago and the price was right around spot, so even at today's spot prices they are probably worth more than I paid.

[Strick]

Reason #1 - high risk, low return, I don't see this as a ligitamate reason. Buy some TIPS instead if you want to fight inflation without the volatility.

Reason #2 - this is not investing, its gambling. If you know the gold market better than everyone else you can win in the long run, just like if you know poker better than everyone else. Given the number of folks that focus on gold (and poker), I'm not sure why I'd chose to try to win at either of these saturated zero-sum games.

Reason #3 - the only "ligitimate" reason I see. Whoever says it "can't" happen doesn't read much history (FMF even gave an example from 1920, which is not that far removed in human years). That said, I guess I'm not much of a survivalist because I see this as something that is so low on the list of threats to wealth that I can't see a person of average wealth wasting their limited resources preparing for it when there are so many more likely threats over a lifetime. Maybe if I had $100 million, locking up $1 million in real gold at a bank wouldn't seem that crazy. (Now that I think about it, most of us probably do have 1% of our assets tied up in precious metals/stones anyway in personal items, so maybe we all naturally have this anyway)

[MonkeyMonk]

I own a number of gold coins that were gifts from my Libertarian grandfather. He's a cagey fellow with his money and although he made a good salary his entire career, he's never had any bank accounts or any other investments as far as I know. I expect that we'll all be knocking down walls and digging holes in the backyard for a number of years after his passing.

[Matt H]

I'm no survivalist, but it seems to me that if the financial system collapses that thoroughly, you'd be better off having invested in guns, ammo and nonperishable food than gold.

[Rod Ferguson]

I own bullion grade gold in small amounts, but my primary PM investment is bullion grade silver (also physical, but much larger amounts). PMs take up about 25% of my liquid assets and about 2% of my overall net worth. The reason I own PMs physically versus through an EFT is simple - no counterparty risk. The reason I own PMs in general is also simple - they maintain purchasing power. Sure, one of my ounces of silver that I purchased at $15.00 is now only worth $11, but when I purchased that ounce, I could buy about 4 1/2 gallons of gasoline with it. Now that silver is $11 an ounce, I can buy... about 4 1/2 gallons of gasoline with it. It all comes down to how you view wealth. If you think of wealth as "numbers of dollars", then PMs are a very bad investment, as the risk-reward almost always works against you (present economic circumstances excepted, of course.). If you think of wealth as "preserving purchasing power for the long term", then there really isn't a better investment than PMs (or hard assets in general, for that matter.)

I advise people regularly to have at least 10% of any liquid portfolio (non 401k, IRA, etc,) invested in physical PMs, but no more than 25% (and only have that 25% if they have counterweight investments to hedge - equities, muni bonds, etc.)

Oh, and Strick - regarding your reason #2 answer about gold investing being gambling... what do you think investing in the stock market is?

[Paul Williams @ Crackerjack Greenback]

Why do people think gold is valuable?

Could it be because...people think gold is valuable?

Seriously, what real use does it have besides jewelry and a few industrial applications? Why would we even think of using it as a currency? Tulips and cowrie shells have been used as currency before (or traded like currency). Basically anything can be used as a medium of exchange if people agree that it has some certain value. The success of using anything as a currency depends on how easy it is to get more of it, which is why tulip bulbs and cowrie shells didn't work very well. Gold might be difficult to mine, but it's not easy to get more fiat currency either (U.S. Dollars) unless the government just starts haphazardly printing tons more.

I've heard people argue that because gold is rare and it's "universally" accepted as currency, then it will always retain its "value" (whatever that is). Again, it only goes back to the argument that because it's scarce and people believe that scarce things are valuable then gold will always be a good hedge against the failure of any fiat currencies.

People have gotten along without trading gold before. (Ever hear of bartering?) If the U.S. Dollar really were to fail (or the U.S. economy), we could revert to a barter system if necessary.

And as a portion of an investment portfolio, gold isn't a very nice asset. Low return and high risk is only good if it is negatively correlated to some other asset in your portfolio (and only then if it's very negatively correlated).

[Wild Bill]

I have over the the bast 25 years accumulated about 60 gold, silver and platinum coins - I travelled internationally and it has been sort of a hobby to buy coins in different countries - Australian, Austrian, South African, Canadian, Chinese etc. Basically a 25 year program of dollar cost averaging into precious metals. They are all in a safe deposit box.

As far as an investment, I have done better with equiry investments, even if you factor in the latest massacre - dollar cost averaging into the S&P over 25 years has been a better deal than dollar cost averaging into gold. my view is that it has been sort of a random hobby, with a return that is about equal to inflation or a little more if I'm lucky, and I can always go to my safe deposit box to play with them.

As far as market timing precious metals, what nonsense. If I could market time I would stay home and do it and be rich.

As far as really tough times, you would be better off investing in a Smith and wesson and MREs. The guy with the Smith and Wesson is going to take your gold.

The last note, and the one to really bear in mind - In the very last extremity, when you are fleeing for your life, as my grandparents had to do from Europe 70 yearsago, a gold coin can (and did for my grandmother's family) buy you out of a situation that could cost you your lfe.

And that is the real reason to have them. Pray that you never need them.

[jeremy]

Let's engage in a thought experiment.

You buy a gold coin today. You put it in your dresser drawer at home, and hold it. Ten years from now, you open the dresser drawer, and what do you find? The same gold coin. During 10 years, the price of gold can go up, it can go down, but the material itself doesn't change, all that changes is what people think it's "worth". In essence, you've bought a something and speculated that someone else would pay you more later. You're speculating.

Now, let's say I buy a share of a company. I put that stock in a drawer. Ten years later, I open the drawer, what do I see? Well, I see the following:

1) All growth the company has scraped an clawed to create.
2) All dividends the company has paid me in the meantime.
3) And a price that people will pay me for the share.

When you buy a stock, you're buying an asset that is actively managed by people to be worth more later. Everyday people get up, and go to work to make your share worth more money. If you buy a good share, at a good price, you'll certainly outperform gold, as you're investing rather than speculating.

Don't buy gold. It's for suckers.

[ekrabs]

I also do not subscribe to the idea that gold is a good investment. A good hedge? Perhaps, but certainly not investment.

Doom & Gloom is not a good way to plan your investment strategy. To the commentator who referenced the Great Depression, we came out of that, for better and for worse, and moved on to many, many other things.

Besides, if you're going to take the apocalyptic route, what you really want to stock on are basic essentials. Canned food. Ammo. Fresh water. Gasoline and Propane. These commodities are far more valuable than a few shiny coins. Especially with ammo, you can defend yourself, you can hunt, and therefore, you can eat. Think about it.

[Paul Williams @ Crackerjack Greenback]

@ekrabs:

You're right about the essentials. If people are really worried about a financial armageddon scenario, then they should be stocking up on essentials and honing their trade skills (farming, carpentry, metalwork, etc.). Those are the things they'd need if the global economy were to ever actually collapse. (Doubtful...)

[Rod Ferguson]

No offense intended here, but you folks should consider reading "The Theory of Investment Value" by John Burr Williams.

[Paul Williams @ Crackerjack Greenback]

@Rod Ferguson:

So how would you justify the price of gold or its use as a currency based on its intrinsic value?

[Jim]

I don't have any money in gold myself. I don't trust precious metals as an investment. My uncle bought some silver in the 70's or 80's when it had a big peak and that served as a warning to me about metals. But I might consider buying gold coins since I'm a coin collector and it would be 'neat' to own some small amount of it.

Gold has not been an exteremely volatile investment in the past 40 years with large boom and bust cycles.

I looked at gold prices in this article:
http://freeby50.blogspot.com/2008/10/historical-prices-of-gold.html
Historic gold prices can be found here:
http://www.kitco.com/charts/historicalgold.html

Heres a couple key points on gold price history:
1971 to today = $40 to $750 = 8.2% annual increase
1981 to today = $600 to $750 = 0.8% annual increase

Jim

[Rod Ferguson]

@Paul:

Intrinsic value is, at it's base, a perception of an underlying "true value" of an item formed from both tangible and intangible factors. A stock is sometimes thought to have an intrinsic value based upon company performance, growth, industry performance, general enconomic factors, etc. This is not to be confused with market value, which you would see as a share price. Just because a share price is low doesn't mean that the stock has no value and just because the share price is high doesn't mean the stock has value. Remember - the price of a share is determined by the last person who bought it, not by any sort of actual value the share might represent. I am speaking theory here; market realities of embezzelment, gross mismanagement, over leverage and such can cause value to disappear in an instant, as we've been given many examples of recently. Hence, stocks contain counterparty risk - stockholders are subject to the actions of others to determine value of the stock they hold.

PMs are sometimes thought to have an intrinsic value based upon functional usefulness, rarity, and thier sometimes usefulness as a monetary base (Eisenhower once explored the possibility of a move to a uranium-based currency; PMs do not necessarily mean "gold"). To your question about the price of gold: gold is still maintaining it's value relative to goods and services. The dollar figure jumps around a lot and people who really want to see gold with 4 or 5 (or 6 or 7) digits being used to show it's price generally forget that gold at $5,000 an ounce will probably mean gas at $25 a gallon (and they'll still need a gram or so of gold to fill up their gas tank - just like they do now.)

To your question about gold's use as a currency: as with any hard asset, gold is finite. Fiat currencies, however, are not. The only thing preventing monetary growth in a fiat regime is human discipline, and humans invariably lack discipline when they can create money. Even in the best of times during fiat experiments, gold does not lose value; but during the worst of times, gold still maintains it's value while fiat becomes worth the paper they are printed on (literally - people may resort to burning currency for it's intrinsic value as a fuel if the price of wood is higher than the face value of the currency).

[Mike Hunt]

FMF,

Gold was only at a high this year at $1000 per ounce, not $1400.

[Sudhir]

Well, I'm from India, and here buying gold is more than an investment... the wealth you pass on to your children is (literally) measured in gold, and its the main investment in the wedding gift you give to the woman you're marrying, and to your children later. So any amount is normally a good idea, because most gold will eventually become jewellery and remain in the family as tangible wealth.

I'm 22 and not married yet, but along with mutual funds (which are draining my money) I'm trying to buy gold. It'll help if there's trouble, will make good gifts, and will stay in the family for a very long time. Dunno about other parts of the world, but here it makes great sense even if the market doesn't do too well.

[Paul Williams @ Crackerjack Greenback]

@Rod Ferguson:

Yes, gold is a finite resource, but my point is that any finite resource could conceivably take the place of gold. I was trying to get across the idea that we humans have chosen gold as the universal currency, but there's no reason some other finite resource (preferably rare and difficult to get) could be used. On that basis, gold is nothing special.

My other problem is with people who believe that gold is not susceptible to inflation. If we mine more gold, the value of all gold goes down -> inflation. It's the same with fiat currencies, we just have to hope the U.S. Government doesn't mine (print) too much.

[Rod Ferguson]

@Paul:

"Yes, gold is a finite resource, but my point is that any finite resource could conceivably take the place of gold. I was trying to get across the idea that we humans have chosen gold as the universal currency, but there's no reason some other finite resource (preferably rare and difficult to get) could be used."

I agree completely and never suggested otherwise?

"On that basis, gold is nothing special."

I would disagree a bit here. I see gold as a superior monetary base for the very reason that it's not very useful as anything else. Uranium, for example, could be used as a base but it's actually more "valuable" in industrial applications. Now if we discover some serious practical use for gold, then I'd agree with you fully as I can't think of another mineral we could use that is quite as useless as gold.

"My other problem is with people who believe that gold is not susceptible to inflation. If we mine more gold, the value of all gold goes down -> inflation. It's the same with fiat currencies, we just have to hope the U.S. Government doesn't mine (print) too much."

Gold is practically inflation proof, even if it's not literally. Certainly with more mined gold the base increases, but that takes time, luck, work and cost. That's why, historically, people have tended to debase gold rather than go find new gold. Flipping a bit on the Fed's balance sheet to add another trillion to the money supply is effortless.

The telling point in your statement is "we just have to hope"; with a hard, finite asset there is no hoping. You simply can't spend what you don't have (create money out of thin air). Napolean was able to wage his war with little effect economically in France - he paid for it with cash on hand in the form of gold (when Napolean came to power, one of the first things he did was return France to a gold standard, ending the era of mandat/assignat currency). When Germany lost WWI, the German economy collapsed as a result of excessive printing of fiat currency (most of Europe went fiat during WWI). People, when they discover they have the ability to create money, do:

http://research.stlouisfed.org/fred2/series/M1

History teaches us is that fiat currency systems always fail - all of them. There is no exception.

[F]

FMF,

I too considered buying gold a while back, as an investment. The question is, why would gold go up? Textbook says:

1. war (I suppose a collapse of the financial system would fit in this category)
2. inflation

And indeed, these 2 explain all the major recent gold price fluctuations (to me). So what about the future?

1: this is already partially factored in to the gold price (watch the gold price rally every time there's a nationalization). So, gold is not cheap today. Besides, personally I don't think this scenario is likely to happen (governments can and will save the system).

2: also already partially factored in. With the economic recession, inflation will drop (we might even see deflation).

In conclusion, I think gold is still expensive today. (And frankly, isn't that what got all of us interested in the first place? When even the newspapers debate the issue, know that we're already in the bubble stage).

Despite all these good reasons for the gold price to fall, it can actually spike if your country's currency crashes (this happened to currencies of some smaller countries like Iceland; there are such fears about the dollar)

[MasterPo]

Ekrabs - Today is not 1929. Wish it was in some ways. Please check this aricle for MasterPo's reasons http://pofile.blogspot.com/2010/02/it-is-not-1929-all-over-again.html (FMF - Pardon the link, just easier than typing it all out again).

[Young Carter]

Though there are ups and downs in the gold rate, people never mind investing in it. When compared to other forms of investment, one can stay safe by investing on gold.