Stock Watch
Is Gold Right for You?
Owning this precious metal might calm your jitters, but the reasons for adding it to your portfolio aren't compelling.
By Bob Frick, Senior Editor, Kiplinger's Personal Finance
October 24, 2008
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.
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.
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Reader Comments (11)
Posted by: Ryan at 10/25/2008 03:47:03 AM
I find it quite humorous that financial planners scoff and laugh at a complete financial meltdown. I bet if we told those same planners, five years ago, that we would experience the worst financial crises since the depression in five years....they would probably laugh again. I am actually laughing at all this paper money the government is printing-with no backing. Crunch the numbers; gold should be worth $2000 an ounce. Gold did cross over the $1000 mark, not even reaching $1100. The strongest argument for gold's lack of performance lies within the gov't itself. Keep in mind that foreign countries are tossing US dollars for gold too. Many do believe it is a conspiracy; if gold was to hit $2000-US currency would be close to worthless. I went back to school and obtained my Finance Degree. Those of us that work in Finances realize planners cry "diversify" to save their own butt. Diversfying is good for a 401k but the concept has yet to make anyone substantial gains. Since the beginning of time, gold is the one currency recognized by all. History also tells us all great empires eventually flounder and/or (go) bust. Since my dollar bills are really only worth 30 cents, maybe I will stock up on more gold. Five years ago while my planner snickered about the plausibility of a recession, I took his advice and sunk my money into an IRA. He thought my idea of buying $300 gold was ridiculous. I explained people are getting loans that will never be repaid. I knew a financial crises was evident the day a car dealership was about to let me finance a $20,000 Mustang because my FICO score was high. I guess they did not care I was in school and made peanuts. The next day I inquired about gold. There are many lesons to be learned during this meltdown.
Posted by: nevket240 at 10/25/2008 08:13:53 PM
Sir: "but all the experts we contacted had a good laugh when asked about this scenario." Are these the same "experts" who saw subprime contained as the Goldlox economy rolled on?? You are more comedian...thats for sure.
Posted by: JHW at 10/26/2008 01:36:05 PM
If I listened to the alleged "experts" instead of doing my own research, I would be a very poor man today. The best advice is to stay out of the equities markets altogether, get out of debt and buy only tangible assets that won't vaporize like stocks.
Posted by: Sam at 10/27/2008 08:08:59 AM
Let's say, hypothetically, that you've got your ducks in a row. Your retirement is taken care of. You have an emergency fund. You've got your house paid off and you pay for your cars in cash. For that person, gold is an insurance policy. If its value doesn't go anywhere, you're still fine, because you've already got your savings taken care of. On the other hand, if the system does implode, you've got your gold. For that person, gold seems like an obviously prudent choice. How much do you want to bet that Bill Gates, with all of his high-powered financial advisors, has a whole lot of gold hidden away?
Posted by: Mr. ToughMoneyLove at 10/27/2008 12:58:22 PM
Most of the gold bulls act like conspiracy theorists who predict the end of the economic world as we know it, with collapse of the dollar and U.S. treasury. Of course, they have been predicting this since 9/11. We are still waiting.
Posted by: AZ Bill at 10/27/2008 01:37:21 PM
I followed all the conservative advice; saved rather than spent, invested in diversified portfolio of stocks,funds, bonds, maxed out on every retirement investment vehicle there is and lived frugally. Now I wish I HAD bought the new car, went on the vacations, and kept what was left over in cash accounts. It's time to stop quoting "Between 1926 and 2007, big-company stocks returned 10.5% annualized, and government and corporate bonds earned 5% to 6% annualized". Start being real and looking at returns back 10-15 years and the truth becomes evident; rethink everything you learned about stock investing!
Posted by: Brad S at 10/27/2008 06:38:53 PM
A few thoughts...1. 1926-2007 is a completely irrelevant time frame when considering equity performance for anyone other than a foundation. 2. Gold (or silver) can not be bought for close to spot price. Finished product gold (coins or small bars) are getting hard to find and commanding high premiums in today's market. 3. Your reason 2 and reason 3 are varying degrees of the same problem. Whether we experience higher inflation or hyper inflation gold prices should rise. The FED will keep fighting deflation with all of its powers until the market turns. When the market does turn the fed will not turn quickly enough and significantly higher inflation WILL follow.
Posted by: Rick Schaefer at 10/28/2008 07:44:56 PM
...you mention that buying gold because the price may go up is risky. Why is this any riskier than buying overpriced homes, overpriced stocks, overpriced bonds any less risky? One could argue that stocks, bonds, and homes are still overvalued and gold is cheap. Gold will be in a bubble one day due to all the Wall Street/Federal Reserve financial shenanigans when no one will trust any paper assets including the US Dollar. Gold is not even close to bubble levels.
Posted by: KEVIN J CHURCHILL at 10/29/2008 11:28:09 PM
I received 250K from an accident at work,and the "Financial Planners" my Boss sent me to meet with begged me to invest 200k with them.They promised a 5 to 10% profit annually, after their fees.I balked and invested 50k in stock and bonds with them, and I bought 100k in Gold, at $300 an ounce, and 50k in Platinum at $575 an ounce. In 5 years, my Stock grew 9% total! This past summer, I sold my gold for over $1025 an ounce, and sold the Platinum for $1275 an ounce with NO FEE's added.And that's not even counting the 1/4 ton of silver I parted with, for triple the price I paid for it. My stocks are DEAD, no growth at all. My Precious Metals did just what they did in 1980.Only this time at a much larger scale. I'm no expert, but metals are way down now, so in a few months it will time to start all over again, and sit back and let it happen again in 5 years.I'll keep in touch, now that China has finally allowed their 1.5 Billion citizens to own Gold and Silver after 40 years of being restricted from possessing any amount at all.
Posted by: Jaspar at 10/30/2008 10:06:09 AM
"... protection from a collapse of the financial system." The author says this scenario is "laughable." But who will laugh last?
Posted by: martin at 05/03/2009 08:01:40 PM
Ben Bernake taught me to buy Gold. In the past my investments earned interest. My house grew in value. When my savings no longer grew, because the prime interest rate went to almost nothing, I went to buy Gold from a trusted dealer. His advice was to get out of any kind of debt first. I did that and Bernake continued to reduce the prime. So I bought some precious metals for insurance and my peace of mind is at an all time high. Everything that I own, except my metals, is worth less now than 5 years ago. If China somehow manages to get some other currency besides the dollar as a primary world currency my metals will buy that currency.