All That Glitters Is Not Gold…

King Midas lusted after it. The Incas worshipped it. Shiny flakes of it set off a 19th-century rush to California and families in India use it to store wealth on the arms of their daughters. Gold’s allure remains as untarnished as the noble metal itself.

Is it the be all and end all of investment? Read on to find out…

Ups and Downs

Since the turn of the millennium, gold has seen a seven-fold rally, a 45% crash and sustained periods where its price moved very little.

Many people live with a doom and gloom attitude and will say things such as “the markets are so volatile gold is your best bet!”

Now I really get a bee in my bonnet when it comes to statements like this. Very often the main stream media feeds the masses with a lot of sensational nonsense which does nothing for client education and more often than not scares them into irrational decisions.

The thing is its price is subject to manias and periods of ambivalence.

The draw of gold, which jumped from around $500 per ounce in 2005 to more than $1,800 in 2011 and then today sits at around $1,500 today, reminded me of some of the past market bubbles we have had.

Booms and Busts

The dot com bubble in the late nineties when everyone piled into those stocks driving the price sky high and most of the speculative stocks crashed badly a few years later. Soon after that everybody was jumping into the real estate market and that of course ended pretty badly come 2008.

Most booms and busts have the same pattern. People like to buy things when prices are high. Maybe they think they’ll miss the chance to make a lot of money if they don’t get in like everyone else. What people forget is prices can fall as fast as they rise. They’re investing based on what’s happened in the past instead of what’s ahead.

Many people were fearful that the process of quantitative easing and printing more money would continue to devalue our currencies and they see gold as a secure constant that their investments will be safe in.

Tulips

Investing primarily in gold could be likened to the great tulip craze in the 17th century where it has been said that at the peak of the market, a person could trade a single tulip for an entire estate, and, at the bottom, one tulip was the price of a common onion. Many believe that much of it was caused through fear and speculation which is abundant at the minute throughout Europe. This type of investment is one that technically does not produce anything but they are purchased in the hope that someone else will pay more for them in the future. It needs an ever increasing pool of buyers who in turn believe the pool will continually increase and expand further.

Bubbles blown large enough inevitably pop and then the old Spanish proverb is confirmed once again:

“What the wise man does in the beginning, the fool does in the end”

There are two major stumbling blocks with gold, one is that it is not heavily used in industry unlike copper or aluminium with the actual demand for gold in industry being so limited that it does not soak up new production. Secondly gold itself is not procreative, if you own one ounce of gold for an eternity, you will still own one ounce at its end. Thirdly, unlike other commodities such as crude oil, cotton, coffee etc precious metals are not consumed, gold is more or less static.

What would you buy?

Warren Buffet gives us a nice little analogy to explain gold investment in simple terms and I am going to use it here.

Today all the physical gold in the world amounts to around 171,300 metric tons, if it were melted down it would amount to a cube 68 feet (20.7metres) per side. Using todays price of $1,500 per ounce that would amount to a value of $9 trillion and we will call that pile cube A.

Now, let’s create another pile, B, costing an equal amount. For that, you could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). What do you think an investor with $9 trillion would do? Select pile A or pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $170 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices (they don’t limit the supply available unlike diamonds, but that’s another article!).

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 171,300 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Questions to ask yourself before you buy

If you’re looking at gold prices, it’s probably a good idea to look at how well the economies of certain countries are doing. As economic conditions worsen, the price will (usually) rise. Gold is a commodity that isn’t tied to anything else; in small doses, it makes a good diversifying element for a portfolio.

If you do decide to go down the gold road you have to decide whether you will buy physical gold or gold shares. Because you can buy gold in many forms, an important question to answer for yourself is what form of gold is best for you.

Owning gold coins or bullion is one choice, but not the only one. Gold in the form of coins or bullion must be stored in a secured environment (not under your mattress). This may involve paying a broker or other firm a storage fee, which can eat into any future profits.

Physically owning gold also has strong emotional appeal – much more so than investing in stocks or futures contracts, for example.

What happens if you need to cash in your gold coin or bullion in a hurry? You shouldn’t have trouble converting your gold to cash, however you will have to take what a dealer will pay.

Gold coins and bullion are often sold at a premium and bought at a discount, so you may not get market price when you need to sell.

Investing in gold securities is not unlike investing in any other security except prices may move contrary to the stock market.

This is not true in each case, especially when investing in gold mining companies. In this case, the price of the stock may reflect the company’s financial health and market position more than the price of gold.

Investing in gold, whether the physical metal or gold-related securities, is a complicated decision and not one to enter lightly.

Allocation

Most financial experts suggest that you should not have more than 10 percent of your assets in gold with the rest being made up of a broad mix of funds that look at spreading your risk via bonds, absolute return funds, structured products, equity based funds and cash. The exact spread is dependent on your risk profile, present age, years to retirement, future purchases, single/married, dependents and of course your future employment status. This of course is only scraping the top of the iceberg and before you embark on any major investment many more things should be taken into account to ensure it is the right investment for you to follow.

If you need help in assessing whether investing in gold is right for you, you can take advantage of my free 60-minute consultation by  Contact Me Today for an initial informal chat to look at ways in which I might be able to assist you with your current financial position.

About the author

Colin MacGregor is an independent financial advisor with over 10 years experience in the advisory sector and  has been based in Prague, Czech Republic since 2009.