Gold prices have been on an almost steady upward trend since 2001. See the following link.
Gold has become the investment darling of the conservative talk radio hosts, and numerous gold sellers have been hawking their product on television and talk radio broadcasts for several years. It does not matter if the investor is rich or poor, or if they are conservatives, liberals, libertarians, Republicans, Democrats or Independents, it seems that everyone has either thought about, or actually purchased, gold as an investment vehicle.
In fact, “gold bugs”, as they are affectionately known, adhere to the policy of buying and holding gold in good times and bad. For gold bugs, gold is as much a religion as an investment.
The first question in an investor’s mind should be whether or not this is a classic investment bubble, similar to the Internet phenomenon that ended badly in March 2000, the biotechnology stock bubble, the real estate investment trust (REIT) bubble, the gaming stock bubble, and every other bubble that occurred over the last 25 years. Bubbles end badly. They are the example of the “bigger fool” theory: you can make money on your investment as long as you sell your investment at a higher price to a bigger fool than you!
Second, ask yourself if gold bullion is really an investment. It used to be considered a store of value, before countries established central banks to control the value of their currency and avoid debasement (weakening) of their country’s currency. Paper was “only worth what it was printed on”, but gold tended to retain its value. Until Franklin Delano Roosevelt suspended the exchange of dollars into gold, and made it illegal for US citizens to hold gold coins, the US dollar was readily exchangeable into gold bullion at a fixed rate of exchange. This fixed rate of exchange served to provide discipline to the Federal government: unwise creation of an excessive number of dollar bills would cause a run on Fort Knox’s gold hoard, as inflation reared its ugly head, and investors lost faith in the value of the dollar and traded in dollars for gold.
In fact, that very thing happened during Richard Nixon’s administration, in response to inflationary forces caused by spending on the Viet Nam War and Lyndon Johnson’s Great Society programs which vastly expanded Federal government spending. Nixon suspended the conversion of dollars into gold on August 15, 1971 as France, Germany and other countries made demands to convert dollars (that they had obtained in trade with the US) into gold. Nixon suspended convertibility to save US gold supplies.
I am skeptical that gold really is an investment. I believe it is a total speculation for several reasons:
1. Gold does not provide a stream of income, as do common stocks, bonds, mutual funds, exchange traded funds (ETFs), money market instruments and Certificates of Deposit. In fact, it costs money to hold gold – investors must pay to store gold in a safe place, such as a safe deposit box at their bank.
2. Nothing about gold is remotely productive. Common stock, which is by definition an ownership interest in a corporation, reflects the earnings of the company after all expenses have been paid. Land, labor and capital (as in capital stock, such as manufacturing plants) are the input costs, and their productive use results in the creation of goods and services that add value above and beyond the input costs. Bonds issued by corporations pay a fixed (or variable) income, depending on the terms of the bond indenture. ETFs and mutual funds are collections of common stock or other financial assets that are tied to income producing assets as well as assets that grow in value over time. Money market funds and Certificates of Deposit pay income, too.
3. Gold is not readily tradable for goods and services. Imagine trying to take a gold bar into the grocery store, shaving off a sliver and handing the sliver to the cashier in exchange for a loaf of bread and a carton of milk. It just doesn’t happen.
4. Gold is used in industrial applications, medical applications, and in jewelry.
5. The gold supply is not fixed, it is variable. The supply depends on central bankers, who have, in the past, put pressure on gold prices by selling gold out of their vaults. In fact, part of the reason that gold prices were low throughout much of the 1990’s was that central banks and governments, particularly in Europe, were executing a plan over a period of years to reduce the gold stocks in their vaults. Russia is one of the key countries that mines and produces gold. If they decided to flood the market with new inventory, the price of gold would plummet. Do you really want your investment portfolio to be tied to the whims of a country such as Russia?
6. Gold demand varies throughout the year. India, in particular, is a country whose people like their gold jewelry, and there is a seasonal demand in early spring each year for gold to produce gold jewelry for Indians.
7. The rather new exchange traded funds (ETFs) that invest in gold bullion, such as the SPDR Gold ETF (GLD), have allowed mom and pop investors an easy way to invest in gold, albeit indirectly. Instead of holding the physical gold, investors with small amounts of cash to invest have the chance to own gold on paper. This is actually a Trust, and each ETF unit represents an ownership interest in the Trust, which is sponsored by the World Gold Council. There is actual physical gold that backs up the SPDR Gold ETF which is held in a vault. The Bank of New York Mellon actually administers the trust.
The prospectus for the SPDR Gold ETF can be viewed at the following link:
8. The newly-created ETFs that invest in gold have resulted in rising demand for gold bullion due to this “democratization” of the investment in gold, as previously mentioned. In fact, analysts have estimated that at least $100 of the price increase that has been seen in gold over the last few years is directly attributable to the availability of these new gold ETFs.
9. Gold is not an investment security, and as such, sellers of gold are not subject to SEC regulation. Therefore, purveyors of gold are not subject to the same laws and ethical rules that govern investment advisory firms and brokerage firms who assist investors who invest in financial assets. Gold sellers are able to advertise and make claims that would not be permissible to investment advisors, including puffery and outright deception.
There are several firms that advertise heavily about investing in gold. These firms advertise investment return statistics that are very selective in terms of the time frame that they use to calculate returns. For example, if you took the gold price as of December 31, 2001 of $272.65/oz. and calculated the investment return as of December 31, 2010 ($1420.25/oz.), the total return would be 20.13%/year, or a rise of 520.9%. This compares to a price change only return for the Dow Jones Industrial Average of 1.62%/year, or 15.53% for the entire period. Keep in mind that this number excludes the dividend income figure, which would increase the total return considerably. But if you took the gold price as of December 31, 1980 ($594.90/oz.) and compared it to the gold price on December 31, 2010, the price return would be 3.05%/year, or only 238.7%. This compares to the price change only return for the Dow Jones Industrial Average of 8.64%/year, or an increase of1193.5% for the entire 30 year period. Keep in mind that the last time that gold was an investment darling, it peaked at a price of $850.00 in 1980. If you had purchased gold at its peak in 1980, your return would have only been 167.1%, and approximately 1.7%/year!
There is also the difference between what the gold purveyors will sell the gold to you for (the "ask" price), and what they will repurchase the gold from you for (the "bid" price). The spread (or difference) between these two amounts is probably considerable and should be asked about before you buy.
Gold is all the rage, and, as professional investors would state, it is a “crowded trade”. The definition of a “crowded trade” is that many investors are taking the same view: that gold should be bought, not sold. Gold is in a bubble right now. As with any bubble, it is hard to know when this will end, but when it does, I suspect that there will be a lot of mom and pop investors whose gold investment did not provide the returns that they were expecting.
Can the gold price increase from here? Yes. When will it be time to sell? It is impossible to know, but probably can only be determined in hindsight.
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