Should You Buy Gold?
These days, flip on the radio and all you hear are ads hawking gold investments. True, gold has been a reliable store of value during times of uncertainty for thousands of years – acting as an excellent hedge against inflation, a bulwark against the debasement of currencies, a backstop guaranteeing the value of paper money (until the 1970s, in the U.S., anyway), and even through the collapses of entire civilizations. Why? It’s combination of scarcity, durability and physical purity.
I remember during the late 1990s – toward the end of the Internet bubble – when tongue-in-cheek investors, flush from easy profits in technology stocks at that time – would laugh at the ‘goldbugs,’ among themselves as a hedge against capital gains.” At that time, the goldbugs were a relatively small and cantankerous group of investors who always seemed to be raining on the stock investor’s bull parade.
Fast forward a decade, though, and we’ve gone through a number of shocks: The tech bubble collapse and subsequent recession in 2000-2001, the 9/11 attacks, the Iraq war and nervousness about oil supplies in 2003, another oil shock in 2008, followed by the severe collapse in real estate and banking industries. Global investors haven’t been able to relax in over a decade – and gold prices have been climbing steadily ever since, to the point where the goldbugs are nearly as insufferable today as the houseflippers were in 2006, and the Internet geniuses were before them.
If you were an alien coming down from outer space, and you saw what we were doing, you would be scratching your head: We have assigned the same monetary value to a single ounce of a particular metal as we do to a month of labor for young blue collar worker working a retail job.
Gold is a rock. It’s a pretty rock. It’s the hammer of the investment world – It has just one moving part: it. But unlike shares in a profitable corporation, it does not create new wealth – nor does it bring in a stream of income. Its value is predicated on two things: 1.) The pure speculation on the willingness of a future investor to pay more for it than you paid for it, which is limited, and 2.) The stupidity and ineptitude of Congress, which is unlimited.
Reason 1 is not sufficient for us to recommend an allocation to gold in your portfolio. We distrust any kind of investing that relies on the assumption that a “greater fool” will buy it from you for more than you paid. That was the thinking behind Internet stocks, real estate bubbles, and many other investment debacles before. We like income and we like cash flows.
Reason 2, however, is powerful. The United States Government has shown little willingness to honestly confront increasingly unsustainable deficits, and even worse deficit projections. Demographics is destiny, and our demographics are going to force Congress to make some very unpalatable choices in future years. Congress has three real choices: 1. Cut benefits severely, 2. Increase tax revenues substantially (which is much, MUCH trickier than increasing tax rates!) or 3. Let the dollar gradually collapse through inflation, fail to index benefits to inflation adequately, and pay benefits and bondholders with future dollar’s worth a fraction of their present value.
Of these, #3 is by far the easier sell to the electorate.
Our view is that gold’s spectacular run-up will eventually slow, and potentially decline somewhat. No one knows when. But as long as the largest economies in the world the U.S. and European Union, are run on chronic and nearly uncontrolled deficits, gold is unlikely to collapse. Indeed, it may well appreciate substantially from its present absurd level.
The real reason to own gold and other precious metals, whether you own it directly, on paper, or via gold mining stocks and shares in ETFs, is because it is an excellent diversifier. When everything else in your portfolio is going to heck in a handbasket, gold is likely to be one of the few things that holds its value. Indeed, in these times, gold can appreciate spectacularly, just as it has for the last dozen years or so.
Diversification
One thing that surprised us was the divergence of gold and real estate beginning around 2007. In the past, we had assumed that gold and real estate together were effective hedges against the collapse in value of paper assets. After all, real estate is as tangible as gold, has similar appreciation potential in normal times, but also potentially generates a nice income stream, provided you buy it at a reasonable price.
But then the unexpected happened (hint: The unexpected happens a lot in investing!), real estate prices began to fall. Banks collapsed as the collateral underlying their loans fell – and gold appreciation accelerated! The correlation between real estate and gold was not as strong as most of us had assumed.
This is a powerful argument in gold’s favor. We love homeownership at reasonable prices. But gold can also help hedge against the possible decline in value of your home. And it has long been a great diversifier against stocks and bonds. It has always tended to zig when paper assets zag.
This is its best role in any portfolio – and that hasn’t changed. We’re not goldbugs. We still believe in the long term value of good stocks in well-run companies with substantial intrinsic value. We believe in the cash flow properties of real estate acquired at a reasonable price. We believe that the interest received from bonds – even at today’s low levels, is a good thing, though there is quite a bit of downside in bonds now and very little upside potential in many of them. But we also believe in hedging your bets, and in intelligent asset allocation. We believe in owning many different asset classes, because asset allocation theory teaches us that a portfolio performs better, on a risk-adjusted basis, when you combine asset classes together.
So don’t go overboard on gold. But it certainly makes sense to own some. And the more reliant you are on the economy and stocks, the more sense it makes to have a bit of gold in your portfolio.
How much? That depends. Everyone is different. Some people have more risk tolerance than others. Some need more liquidity. Some need as much dividend income as they can get. Some have other assets that are good diversifiers against stocks and bonds, and so they would need less gold as a counterweight. Others need more. That’s where we come in – our job is to help you work through these issues and help you make informed decisions. Don’t listen to the gold hawkers. Get a balanced view, from someone who understands your overall situation.
Tags: diversification, economy, education, gold, inflation, investment advisor, oil, portfolio, psychology of money
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By Andy Hough, February 3, 2012 @ 10:59 am
I don’t have any plans to buy physical gold mainly because it is a hassle to buy. I do own a gold and natural resources mutual fund that has been doing pretty well.
By 101 Centavos, February 4, 2012 @ 6:47 am
I don’t know that gold is alone in being a non-producing asset. So is cash. Holders of large amounts of cash are penalized by bank fees and inflation. Me, I like precious metals: coins and bars, ETFs, mutual funds, and mining companies. But I also like to diversify.
By Brent Pittman, February 4, 2012 @ 11:09 am
No plans on buying gold directly here. I own a variety of mutual funds, and several of them have mining companies and gold in them. That’s the joy of mutual funds right?…the risk is spread around.
By Evan @ smartwealth, February 6, 2012 @ 6:57 pm
like the other people that commented, I have a mutual fund that invests in gold etc, that is as far as I will go into buying gold though. I thought I had missed the boat a few years ago, but gold prices have been much more stable now than in past years
By Kent Smith, February 7, 2012 @ 1:32 pm
I’ve heard it tossed around that an old rule of thumb was to place 5-10% of your assets in a portable commodity w/crisis-value, like gold. If you invested $100K in 2002 and you adjusted each year to have 90% follow the S&P and 10% be held in actual gold (not shares in gold companies – actual gold metal), you’d have had 160k at the end of 2010. Without gold (just S&P), you’d have had 130K. If you didn’t sell/buy gold to keep it at 10% of your total invested, but just let 42 ounces ride from day 1, you’d have 176K. In 10,000 years of settled human existence, we have seen, for one reason or another, collapse after collapse – times when survival depended on portable non-perishable ‘desirables’ like gold. This has even happened in living memory. Despite the facts of history, it does seem hard to imagine a time in the future when one’s life may again depend on what one has sewn in the lining of one’s coat. Furthermore, the current price of gold makes a 10% move in that direction seem riskier and far more painful than such a move might have seemed a mere 10-11 years ago, when gold was going for $240/oz. If the s**t does hit the fan, it seems to me that only those who entered the room in 2002 with a gold-type hedge will come out completely clean-faced. You mentioned above that scenario 3 (crazy inflation) is most likely, which is when gold would be worth the most – yet you do not advise investing strongly in the return that would be highest and most certain under your own analysis – painful and frightening as it would be at the moment to make such a move. Why?