It seems that every time you turn on the television or listen to the radio, you're inundated by advertisements about buying gold. The ubiquitous advertisements state that gold prices are at record highs and urge the viewers to sell their gold for amazing profits or to buy gold coins that "will only go up" in value. But it's not only these "get rich quick" advertisements that exaggerate the merits of speculating in gold - now respected investors such as John Paulson, who made billions betting against sub-prime mortgages, and George Soros, who bet against the British pound, are pouring millions into gold stocks and funds.
Fortunately, there are many avenues for the average person to invest in gold. You could buy the actual gold itself, usually in the form of coins or bullion, but there are several drawbacks. First, there is the hassle of having to find a secure place to store the gold. Second, it will be more difficult to sell your physical gold because you will have to go to various dealers and then go to the trouble of negotiating a fair price. There is also a potential "Black Swan Event" with respect to holding gold. A Black Swan Event is something that is very unlikely to happen but if it does, it would prove to be surprisingly pernicious. In this case, the Black Swan Event would occur if the government decided to seize all privately held gold, which happened during the Great Depression with President Franklin Delano Roosevelt. Although this is highly unlikely, our national debt is increasing by the day, and the government could decide to seize and then sell it back to the open market in small amounts at full price, to fill up its coffers.
The easier way to invest in gold is to buy shares of gold mutual funds or exchange traded funds. Gold mutual funds and ETFs are funds managed by professional investors who buy and sell gold stocks - such as gold mining companies - which they believe will have the best future return. ETFs are probably the best bet because you can trade in and out of them like stocks, whereas your money may be locked into mutual funds. Of course, enterprising investors can try to select individual gold stocks, and even though you will not own actual gold, these funds or stocks tend to mirror the spot price of gold. Buying equities is another less risky option because you do not have to worry about the storage of a physical asset and you can sell very easily for the standard market price.
Before investing in gold, however, it's important to understand why it is currently such an attractive investment. For example, although stocks have remained flat and are just recovering from the recession, the price of gold has shot up an unbelievable 177 percent in just five years. This increase is mainly because gold's price tends to spike when there is fear of inflation. As analyst John Bridges of JPMorgan Chase explains, "inflation reduces the buying power of your currency, so people will pay more for things that retain their value when there is inflation." Translated into today's economic situation, this means the government is printing boatloads of cash, and interest rates are close to zero, a policy which leads to inflationary fears.
Global unrest also tends to drive up the price of gold because it is commonly thought to be a safe investment. Because the amount of gold is relatively constant and is universally accepted as valuable, unlike currencies that are valued in relation to each other, investors flock to this precious metal. The poor financial condition of the PIGS nations - that is, Portugal, Italy, Greece and Spain - combined with uncertainties created by the financial reform bill and our debt creates a lot of uncertainty. Markets do not like uncertainty and because institutional investors need to deliver returns to their clients, they pile their money into the safe haven of gold. This is a trend that repeats itself in periods of high inflation across the world. During 1980, high inflation along with the Soviet Conflict in Afghanistan caused gold prices to soar to about $850 an ounce, which would be more than $2,000 today if you adjust for inflation. Like all bubbles, it quickly bust, sending gold back to a more reasonable level where it remained for about two decades.
Although it seems like a good way to make money when other markets are falling, gold is historically a poor investment. If you bought gold in December 1994 for about $400 an ounce and waited until early 2003 to sell, you would only have broken even. Taking inflation into account, you would actually have lost money! Except for the spike during 1980 and this current one, gold has remained relatively flat. Gold stocks also can be risky investments even during times when gold is climbing because not all gold mining companies are equal. Some firms do worse than others, incur higher expenses or experience delays in their production. All these factors can make stock prices fall even if the price of gold goes up. As a result, the gold market tends to be more speculative than the general stock market because traders have to guess the potential effect of future events, such as inflation, and then decide to buy or sell gold. In the stock market, companies release reports detailing their current situations, from which analysts predict whether or not companies are worth buying. The market participants react to these predictions and buy and sell to set the stock price; thus, solid companies generally are worth more than weak ones.
Overall, gold, or metals in general, should be considered as part of a balanced portfolio, but the current gold rush could leave speculators with empty pans.
Harrison's column runs biweekly Wednesdays. He can be contacted at h.freund@cavalierdaily.com.
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