Gold is probably one of the most misunderstood areas of investing and economics. Investors typically are split down into one of two irrational groups — those who always think gold is worthless and in a bubble, and those who always think gold is on a permanent one-way trip to the moon. The truth lies somewhere in the middle.
Let’s look at the facts about gold, without ignoring a basic understanding of economics principles and economic history. Hint: both pop-investors and gold bugs are often wrong.
In this article, we’ll look specifically at how gold behaves in the long-term, and what kind of portfolio adequately has gold without going too far to an extreme.
A Few Basic Pro-Gold Facts
Anyone familiar with gold probably knows that plenty of “experts” look down their noses at gold. Many often see it as a barbaric investment. Even Warren Buffett — famous for using high-leveraged equity plays to build a fortune — mocks buying gold, saying that it’s nuts.
Unfortunately, being really good at making money via stocks often makes people blind to the alternatives — like land, gold, and silver. Here are a few undeniable facts that the pro-gold crowd should be familiar with.
1. Gold is safer than TIPS, bonds, and stocks. There is absolutely no way around this — gold doesn’t go bankrupt, doesn’t ever become completely worthless, and over time will beat inflation. TIPS, bonds, stocks — they can’t say this. While a diversified portfolio will out-earn gold over time, gold mixed with a portfolio makes it more secure, and acts as a type of financial insurance. Any of the investment “experts” who might disagree just needs to brush up on economic history.
Of course, by “safer” I don’t mean “more likely to earn money”, I mean “more likely to not become worthless.”
2. Gold is a fantastic diversification tool. When people lose faith in the system, gold goes up. People claim this is because of “fear”. I think it should be more appropriately seen as a measure of the general uncertainty about the system which is often extremely understandable. Stock crash of the 80s? Made gold go through the room. Stock crash of 2008-2009? Well, that’s also put gold through the roof.
As a diversification tool, gold mixed with stocks can make a portfolio much stronger over time, much less volatile, and even much more lucrative if rebalanced correctly.
3. Gold beats inflation over time, period. This is essentially unavoidable. Even though the price of gold is often manipulated by central banks and large financial institutions, it’s always been worth something — enough to sit up and take notice if you see a gold coin on the ground.
If you had 1000 ounces of gold back when Jesus walked the Earth, then you would have been a rich person. The same is true now — you’d have a million and a half dollars. No publicly traded company, no bond, no Treasury Bill, no [fill in the blank] comes close to such a record. Land is sometimes worthless, companies go under over time, governments collapse, currencies dissolve, silver prices have been essentially worthless before… but gold has always been worth a subtantial amount.
Of course, that gold is such a great inflation hedge is also a strike against it in a sense — if your investment just keeps up with inflation over time, then you can’t exactly claim that it’s a way to generate wealth in and of itself over time — the entire appeal is that it’s charts should look relatively flat over the course of a thousand or so years. The only way to actually get “wealthy” with gold is through speculating through the different gold market cycles.
Because of this, gold is best invested by the average person not as a way to make money, but as a way to hold on to one’s money. A “doomsday” insurance policy, in a sense. Because it often counteracts stock-market drops, it can also be used as a good way to make money via rebalancing over time — as a type of stabalizer of your portfolio in case of bear markets for stocks.
What do you think about gold? Do you own any Gold? Do you think it’s old fashioned? Is our current gold market about to collapse or go higher?
This was an article written by Shaun Connell
I love this post because I believe the truth is in the middle. I am not a gold bug. I fully believe that it will someday go down substantially in price. But I do own gold and for the reasons that you mention. It is my “doomsday” policy guaranteed to have some value and possibly allow me to start over if necessary.
Derek Clark says
I’m not convinced. While gold can’t go bankrupt like a company, gold is essentially worthless. There is no value to it other than the value that other people give it. Buying it you are hoping for a “greater fool” to come along and buy it higher (or at a similar price as the case may be). While I agree with the sentiment of the article as this is how it has been valued for a long time, there is still no rational reason for it. If a real “doomsday” scenario happens, gold is worthless. Water on the other hand, that is worth something.
I don’t know enough about gold to form an educated opinion about it.
However, my initial thoughts are that it’s probably somewhere between worthless and fail-proof.
I don’t own any at the moment, but wouldn’t be against it in the future.
Do people buy physical gold, or investments such as stocks or ETF’s?
I agree with your balanced approach to possibly owning a little gold in your portfolio. However, I would like to point out the fact Gold keeps up with inflation is not a good reason to own it unless you have massive inflation. An investment that only keeps up with a “normal” inflation rate is a very poor investment. Factor in the costs of investing in gold and you have a investment that is a real drag on portfolio performance.
The Arbor Asset Allocation Model Portfolio (AAAMP) currently holds a very small position in gold stocks (less that 2% of the portfolio). A properly asset allocated portfolio is the best means of building long term wealth.
Jack Foley says
Warren Buffett on gold in some interviews during the BRK shareholder meetings:
“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM), and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils (NYSE:XOM).”
For me, the only gold I will own is in my wedding ring which represents something much more valuable than the $200 of gold in the ring. Let me invest in something that’s actually capable of doing something.
Chris @ cfcents.com says
Great article, and I do believe that you are the correct in that the truth lies in the middle.
I always kind of chuckle at the Glen Beck’s of the world that say they buy gold as a doomsday scenario protection. Really? Gold won’t matter, guns will.
Peter Anderson says
Haha.. so true. Guns, ammo and water storage tanks are where it’s at! Buy now!
While I don’t want to be a hater, I have to say that Beck’s pro-gold rants are pretty bad. He tells them to contact Goldline, who then does bait and switch from gold bullion to “rare” old and overpriced coins. Grandma’s will listen to Beck, call the number, and then lose half their life savings within minutes. I don’t know how those kinds of people live with themselves.
Derek, of course the value is found only in demand — that’s how all investments work. Gold is essentially a natural currency. All investments are only worth something because of demand — for example, dollars.
Jack, that’s a good argument against gold vs farmland. There’s no reason to make that choice — both are good investments depending on one’s investing strategy. Gold should only be part of one’s portfolio when one thinks economic turmoil is going to keep getting worse — for example, in the middle of the financial crisis, or back in the 80s. It’s a refuge investment — not a retirement investment. Different investments for different aspects of one’s long-term strategy.
Mrs Sunshine says
Is that real gold or stock in gold that we are referring to?
I know that past history is no indicator of the future, but the thing I like least about gold is that the best times to get out of it are every 20 years or so. And the whole taxation thing…physical gold is taxed at the income rate, regardless of how long you hold it.
As mentioned in the article, gold is a great diversification tool. I think some people are so passionate and they go overboard. I’ve heard tragic stories of people going all-in with gold. Even “gold bugs” should only hold a SMALL portion of their retirement in precious metals. Invest too heavily in gold and you’re no longer diversified! I know there are a few ethical gold dealers out there that actually will not let a client move ALL of their funds into gold.