Why I Think Gold is a Loser Investment

In my recent interview with a gold and silver expert, I tried to get at the fact that it seems easy to buy gold at full retail price (or even higher -- much higher when you add in some fees) but not as easy to sell it at a good price. I didn't develop the concept fully in my questioning (my fault) and it was still lingering when I ran into these thoughts from the Wall Street Journal:

It is a lot easier to buy gold than to sell it—at least for a good price.

Some will give you as little as 10% of the meltdown value for gold jewelry and coins. Many jewelry stores, including Kay Jewelers, a unit of Signet Jewelers, pay about 50% of the meltdown value. Coin shops tend to pay more: up to 80%—assuming the coins don't have a higher collectible value—and a few online players may offer as much as 90%.

Let's make a few assumptions and see how this plays out:

• Jimmy buys one ounce of gold (a few years ago -- I'm using round numbers, not today's prices, for ease of illustration) for $450. In addition, there are fees that bring his total costs to $500.
• The price of gold doubles to $900.
• Jimmy wants to cash in so he goes to a local coin shop and gets $720 (80% of market value).
• So while the price of gold has gone up 100%, Jimmy's gain is only 44% ($720-$500)/$500.

This is not the formula for a winning investment IMO.

Sure, Jimmy could have done a few things better (like having lower buying costs and selling for more.) But even in an almost optimal situation where he incurs 1% costs of buying and gets 90% of market value for his gold, he still only makes 78%.

Yeah, making 78% is still good -- especially if it's within a year. Or two. Or three. Or even four. But doesn't it seem like the investment isn't all that it should be? He's losing 22% along the way! Or maybe I'm not looking at the situation correctly (he does, after all, still make a good return.) You tell me.

Or look at it this way. Under the original scenario of fees and 80% selling price, the price of gold needs to increase by 39% (from $450 to $625) just for Jimmy to BREAK EVEN!!!! Even with the second, more generous assumptions, the price of gold still needs to increase 12% for Jimmy to be in the black. This is simply crazy!!!!! What investment would you want to go into knowing that you had to make 12% to 39% just to get back to even? Answer: none. IMO, this is why gold stinks as an investment.

Now if you could sell gold easily and much closer to market value, then it would become a better investment. But it seems to me that the cards are stacked against all but the most sophisticated investors here, so only "experts" will get anything close to market value. Again, maybe I'm wrong. Those of you who know better can enlighten me if that's the case.

So until I'm convinced otherwise, gold is out for me as an investment. That said, there are other reasons for buying gold -- for the "insurance" factor. The following was noted in part 3 of my gold/silver interview:

The first allocation [of gold] should be under the mindset of never selling it. It is the “insurance” against dollar default.

To me, this seems like a valid reason to purchase gold -- if you believe in the total collapse of the economy/gold will hold it's value while inflation runs rampant theories. But for purely investment reasons, I don't see how gold represents anything but an investment that must increase in value SIGNIFICANTLY for you to earn anything resembling a reasonable return.

Again, please tell me where I'm wrong -- I'm open to being corrected/learning more...

Comments

[Mike Hunt]

Interesting post.

I live in SE Asia and you can buy 1 Oz gold ingots with local shop information chopped into the gold. These are from businesses that have been around for 80 years or so. The buy / sell spreads are only about 1% or so. When the price of gold goes up the merchant is obligated to buy it from you, however it's not as transferable as American Eagles or something similar.

It's not uncommon for people to keep their money in gold and sell it when times are tough.

I bought a few ounces back in 2008 for $7XX per ounce, back then you had to pay 100% of the money up front and wait 30 days for the gold to be ordered and delivered.

I toyed with buying $50 - 75K worth in a shot however the following challenges came to mind:

1. If I purchased a large quantity there is more incentive to cheat me by making a few ingots with more copper or shaving off some weight- I don't have a means (acid test) to ensure it's good enough quality.

2. I have some concerns about taking that much gold out of the store, I've heard stories of people following big purchasers to rob them later.

3. Nervousness of a robbery at home or even knowledge of anyone being aware we had that much gold.

So in short, we didn't buy more than a few ounces which we still have today, in the closet.

If the USD implodes then the value of gold will probably plummet also. If there is no form of recognized cash then we are back to bartering things and gold may not fetch such a good price anymore. It's tough to say what would happen with gold, but the fact that the price is so high is a deterrent. There has been a big drop off for jewelery purchases now and it seems all the hedge funds are the ones buying gold- seems like this may not end so well.

The USD is still precious in the sense that there are many who cannot find work or who have to take a pay cut.

As Pink Floyd says: "But if you ask a pay rise, it's no surprise they're giving none away."

-Mike

[Everyday Tips]

Very interesting, I had no idea it was so difficult to get a fair price on gold. You are definitely making me think twice, although I think gold is too high for my tastes right now anyways.

[Tyler]

Its a lot easier to buy a house than it is to sell a house. 6% of the sale price is paid in commission to the agent. so you are really only getting 94% of your sale price. How often does a seller get their ask price? So lets count that against the sale price.

All markets have a bid/ask and a commission.

Some have higher spreads with less liquidity and some have higher commission rates. You need to know these costs and use this information in your analysis.

I am not a gold bug, nor do I hold physical gold as an 'investment'.

[bb]

Whoever buy "physical" gold pays to touch and feel the real gold. The best way to buy gold is to buy gold ETFs, period.

[Bruce]

There are other, cheaper ways to diversify with gold....Goldmoney (1-3% to buy and sell combined) or can buy the GLD ETF which is no more/less expensive than holding most other ETFs.

[Dave]

SGOL is another great gold ETF - 1bp lower expense ratio than GLD and the physical gold is held in Switzerland (vs GLD in London).

Read Peter Schiff's "Crashproof" books and decide for yourself how much gold you want.

[Keith]

I believe that if inflation runs rampant and the dollar completely loses value, all you'll have is a gold colored rock. If you're hungry and need food, and if I have food. I'm not going to trade you my food for your gold colored rock. I'll want something actually useful. It only has value if someone is willing to actually pay you for it. So you could end up with a really nice paperweight if anything did happen.

[Rod Ferguson]

I've said it before - PMs are a lousy investment. As a store of wealth, however, nothing is better.

I suppose another way to look at it, FMF, is if you are looking to save wealth, then consider PMs over, say, putting your savings into the stock market. If you are looking to use your wealth to try and create more, then consider the stock market over PMs. You shoudn't put your savings into the market and you shouldn't try to "make money" with PMs.

[Bruce]

Keith, there are plenty of reasons to own gold other than the scenario you propose. And, lets to be realistic, you're only going to keep your food if you have a bigger gun than the guy next to you. And at that point everything is worthless anyway (stocks, bonds, etc).

People who own gold aren't necessarily predicting a doomsday scenario. If they were they'd likely be stocking up on guns, ammo, food and a nice cabin in the middle of nowhere instead.

[Rod Ferguson]

Oh - and FMF... notice I said 'wealth' and not 'money'. It's all about the purchasing power; the number of dollars is irrelevent except at the end (when you wish to use your wealth to pay for a good or service).

[Rod Ferguson]

Keith - I own a couple of longarms, a few boxes of ammo, have about 4 months of food in the pantry and am building a cabin in the middle of nowhere. I call it 'retirement', though ;)

[FMF]

Rod --

Interesting thoughts. What do you think of land/real estate (bought correctly, of course) as a replacement for PM in your thoughts above?

[Chalmers]

I think of gold sort of as an end-of-the-world apocalypse type investment. It's what you'd use to bribe your way onto the last departing helicopter from the collapsing metropolis after zombie-Nazis on dinosaurs destroy us when our economy collapses, digital banking is offline and our paper money has no value. Consequently, I don't have any gold.

[Rod Ferguson]

Also a good place to store wealth - and has the added benefit of possibly producing something (which can grow your wealth). The downsides are non-portability (try taking a 6'x6' section of land to a store and see if you can buy milk with it), taxation (requires wealth to maintain ownership) and effort (fallow land tends to lose value and effort is needed to make it produce). Just like I wouldn't put 100% of my savings in PMs, I wouldn't put 100% savings in land either. But, I do own both, and both serve multiple purposes for me.

On that note as well, I've been thinking one of the likely ways we'll end up servicing our debt is food production. As the developing countries "develop", they will increase the quality of their respective diets. That means high nutrition/calorie foods, especially those that can be preserved for travel. In the US, we're still one of the best food producers in the world. I haven't made any movement yet, but might very soon begin investing into agribusiness, with an emphasis on fertilzers and preservation. If I do make that move, I will also begin considering investing in farmland for production. These are investments, of course, and will not be funded with savings, but if I take the plunge in farmland, that will factor into my portfolio as a savings percentage.

[FMF]

Rod --

Interesting that you should say that. I'm considering buying some farmland/wooded acreage that I then rent a portion of to local farmers. The parcel I'm considering generates 5% annual income (from the purchase price) and has few expenses, so it's not a bad idea. Couple this with your food production theory and the land may even have more value in the future.

[Squirrelers]

Interesting observation. Should be obvious, but it isn't for many people - and I have to say that included me as well.

With those transaction costs, it makes it very difficult to recommend purchase of gold in physical form. I still say as a long-term hedge it might be ok, but these transaction costs are very high and need to be considered.

I think this is a bigger issue, where people need to consider transaction costs with every "investment". The overall returns in such vehicles can look much different when factoring them in. This concept is right in front of us with load/no-load mutual funds, but needs to considered with every purchase.

[Charles]

There are some sites out there that you can sell PM pretty close to the spot price (eg: eBay, bulliondirect.com). I use those to reduce my expenses of buying/selling down to a 2-3%.

I'm more of a speculator than a long-term investor on it currently, bought some silver before QE2 and sold shortly thereafter for 20% gain in a month. PM's are pretty volatile these days...

[Shaun]

While I'm a huge fan of owning physical gold, I completely agree with the idea that it shouldn't be purchased for quick profits at all. It's an insurance move, not a traditional investment.

I still use the word "invest" when talking about buying gold, but that's because I view insurance as a type of investment as well. Not all investments are short-term profit oriented.

Great article.

[Rod Ferguson]

FMF - unless you plan on preserving the wooded portion, consider selling the trees for a quick lump sum and replanting. You usually don't recover your purchase price in lumber profit, but it can take a nice chunk out of the overall cost.

Charles - PMs are always volatile. The only thing worse is currencies. Personally, I wouldn't trade PMs like I would trade stocks. Too great a chance to lose your shirt in a very short time.

[Alias]

Gold is a waste of money for small time investors and for the most part, individuals. If you really believe in doomsday and the collapse of US and other fiat currencies, then perhaps you can pony up a few grand for some canned food, bottled water and firearms with plenty of ammo. Those who buy now, are entering a realm of speculation....

[MBTN]

I never bought into this whole "gold as a store of wealth" business. The gold bugs' argument is that dollars are "fiat currency" meaning that they only reason they have value is that people have been convinced that it has value. When that illusion is punctured, dollars will just be pieces of paper. I always give the counterargument that gold is a "fiat metal". The only reason that it has any value is because people are convinced that it has value. Gold has no practical use except for making pretty jewelry, and maybe using a bar of it to fend off an attacker. At least you can burn dollars for fire or use it as toilet paper in a pinch (although it is just a step above sand paper in that respect).

Gold as a store of wealth is as much an illusion as dollars as a store of wealth. I agree with Alias that if the dollar collapses, nobody is going to care about gold. They are going to care more about practical items like food, water, diesel fuel, ammo, and chickens. In that scenario, I would rather trade for something useful than for a hunk of useless yellow metal.

[MasterPo]

MBTN - Gold has been a source of wealth and medium of exchange pretty much from the start of human civilization.

Short of a world wide cataclysm resulting in a "Mad Max" aftermath it's unlikely gold (and silver) will be worthless.

[Mike Hunt]

Don't forget gold lost 80% of it's value over 20 years, during a time of high inflation. Adjusting for inflation, the people who bought gold in 1980 are still underwater on their investment.

New supplies of gold come into the market every year, and little if any gold is taken out of the market.

Gold does not produce any income or yield unless you are lending it out at interest or making electronic based ETF funds based on claims of gold- that's the problem with the ETF's, it would be hard to make physical delivery and there are multiple claims on the same gold. A lot of ETF's look at futures contracts so there the added effect of backwardization and contango.

-Mike

[Gold Trader]

This is true in western countries that it is harder to sell physical gold. It is a different story in the east though. Take a visit to China and you will get a better understanding why the price is rising. Gold is sold in retail banks and there are gold shops everywhere. The Chinese government are stocking up and telling their patriotic citizens to buy.

[Cal West]

You folks don't know much about gold...
I went to a coin dealer and bought 1oz gold eagles for 5% over spot price.
(1000.00 x 5%=1050.00 for each coin) about 18 months ago.
I just sold those gold 1oz coins for the current spot price of 1350.00 each.
Net profit, 300.00 per coin. When buying gold or silver deal with a coin dealer who knows the current spot price of gold and silver. Everything is bought and sold by the "real time" value of the asset. KITCO.COM has a spot price add-on to download to your task bar. Never pay more than 5% over spot price for any gold or silver coins. I don't know anything about gold/silver jewelry; due to the fact that the value lies in the karat weight. (24vs14vs10kt) Stay away from buying jewelry containing gold/silver. Coins are the easiest to buy/sell and are known by any person/company dealing in metals. MIS-INFORMATION is very harmful to the coin industry. Research your product before buying!

[aaktx]

Gold is a goose that has to be stored and guarded. It does nothing and secures nothing. Currency concerns notwithstanding, useful objects(as mentioned earlier) are a better store of value. I think gold bugs are a bit nihilistic.

[David]

You don't have your facts straight. PMs purchased as coins are easy enough to buy and sell. You will pay a standard mark-up over the spot price to buy and receive a standard mark-down over the spot price to sell. It is far from 50%. More like 2-5% with reputable dealers.

And Mike, far more new supplies of paper and electronic currency come on the market each year than supplies of gold.

Physical gold is a traditional inflation hedge. Many have been convinced by the Goldman Sachs of the world to scoff at investing in something that has been considered money pretty much forever and which was money in the U.S until 1971.

As for doomsday scenarios, it is certaily true that no fiat currency in history has ever survived forever. Gold may be equally valueless if there is a complete breakdown of society, but even then, assuming societies rise again in the future, gold is far more likely to have value than the currency it co-existed with.

Finally, ETFs are great unless one of the reasons for buying gold is that it is a store of value independent of a debt. An ETF is a debt you are owed--a debt which the debtor may not honor when the chips are down. Physical gold is not.

All this said, should everyone invest in gold? Some smart people with nothing to sell you say no, and other smart people with nothing to sell you say yes. So you just have to decide for yourself.