Stock Watch


Is Gold Right for You?

Bob Frick

Owning this precious metal might calm your jitters, but the reasons for adding it to your portfolio aren't compelling.



Nervous? You may think owning a little gold can calm your jitters in these turbulent times. There's something soothing about the lustrous metal, which has been the go-to store of value for thousands of years. If gold will calm your frazzled nerves, then stock up on a bit of it. We'll give you some good options later on how to do that.

But from a hard-nosed investing point of view, owning gold isn't compelling. There are three reasons to own gold, but one is debatable, one is risky, and the other is downright scary.

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.

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By contrast, the other stuff in a well-diversified portfolio has definitely outpaced inflation. Between 1926 and 2007, big-company stocks returned 10.5% annualized, and government and corporate bonds earned 5% to 6% annualized, according to Ibbotson. Inflation over that period was 3.0% annualized.

So yes, gold can cut volatility in the same way thrust reversers slow a jet as it lands. But gold can hamper a portfolio's growth over the long term.

Many planners prefer commodity funds to gold. These funds -- which own stocks of companies that produce such commodities as oil, steel or gold, or which track a commodity index-can dampen a portfolio's volatility, just as gold can. But they may offer a greater return over time, advisers say.

The other problem with gold is that most investors don't own enough for the position to make much of a difference in performance. Advisers typically say you shouldn't have more than 5% of your portfolio in gold. Given gold's volatility, that's responsible advice.

But like a bay leaf in a big pot of soup, the impact of a 5% holding will be minimal. Say you put that percentage of your investments in gold, at $600 an ounce, just as the financial crisis was starting to accelerate a year ago. As of October 24, gold fetched $732 an ounce. That's a 22% gain -- terrific in comparison with everything else. Figure the rest of your portfolio is down 25% during that time. Thanks to the gold stake, your portfolio's total loss has been reduced to 23%. That's some small comfort.

If you sold near gold's peak last spring and made 66% on your money, your overall loss would have been 20%. That's much better, but you would have been extremely lucky to sell near the top.

Reason #2. The second reason for buying gold, the risky one, is simply that you think its price will rise substantially. Standard & Poor's analyst Leo Larkin says that attempts by governments everywhere to prop up their economies by flooding the world with money should lead to a major increase in inflation down the road. "In three or four years, I don't see why gold couldn't be at $2,000 an ounce," Larkin says.

Maybe. But keep in mind that even when gold was trading at $1,000 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 has fallen 27% from its spring peak.

This underscores gold's volatility and lack of predictability. Experts say that the price of gold has fallen during the current crisis because hedge funds and big institutional investors have sold gold positions to cover redemptions. The surprisingly strong dollar, they say, has also hurt the price of gold (the metal's price typically moves inversely with the greenback).

Financial planner Bob Frey, in Bozeman, Mont., essentially argues that gold is expensive and all other kinds of stocks are cheap. "Gold is still in a bubble. It's up 200% from a few years ago, and you have to weigh that against U.S. and European stocks that are down more than 30%."

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.

In the end, none of the three reasons for owning gold carries much weight. But maybe you ache to own gold, come what may. 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).

Both are designed to track the price of bullion and to do so reasonably well. Year-to-date through October 23, both funds lost 14%, precisely the same as the decline in the price of bullion. Avoid individual gold-mining stocks -- their volatility is off the charts. The same goes for mutual funds that specialize in gold-mining stocks. The average gold fund lost 61% year-to-date and plunged an astounding 52% over the past month alone.

Here's a thought: 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.

Okay, but while you caress your coins, don't think of them as an investment.

QUIZ: Test Your Knowledge of Gold



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