Gold investment:
is it still a good idea to invest in gold?
Is investment in gold a great idea? Maybe this seems like a rhetorical question given the fact that it’s gone up 500% in a little more than a decade. However, there’s more to this discussion than meets the eye. For example, during the 20 years preceding the recent price rise gold had lost about 80% of real (inflation adjusted) value….over a 20 year period! However both periods, good and bad, are behind us. Is gold investment a good investment today? Why or why not? Below, we list 17 reasons to the contrary.
- Warren Buffet put it well, "Gold gets dug out of the ground in Africa, or someplace," he said. "Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."
- Gold is volatile. It's hard to value. It generates no income. Investments generate cash flow (rent, interest, profit, dividends). Investors determine the value of investments by calculating the present value of future cash flow. With no cash flow, gold is worth what people are willing to pay for it. Thus the prices can change very quickly on a whim of investor sentiment.
- To underscore the volatility, look at the price drop for silver the week of May 2nd 2011. After reaching a 31-year high of $48.58 an ounce on Friday April 29th 2011, the metal sank $2.51, or 5.2%, on Monday, then 7.6% on Tuesday and 7.5% on Wednesday. On Thursday silver was down another 8%, or $3.15, to $36.23 an ounce. That’s a 25% drop in a week!
- Gold is a currency "substitute," but it's useless. In prison, at least, they use cigarettes: if all else fails, they can smoke them. Imagine a bunch of health nuts in a non-smoking "facility" still trying to settle their debts with cigarettes. That's gold. It doesn't make sense.
- As for being a "store of value", anyone who bought gold in 1980 and held on lost nearly all their purchasing power over the next 20 years.
- What if the price goes back to where it was just a few years ago, at $500 or $600 an ounce? Will you buy more? Sell?
- Everyone knows the price of gold has risen about five-fold in the past decade through 2011. But this is not due to some mystical truth or magical act of levitation. It is simply because there has been more demand than supply. That can change.
- Gold's supply (mostly through mining) has consistently exceeded demand for professional uses. Thus, the price is rising merely due to hoarding. What happens when hoarders turn to sellers?
- Lots of people have been buying gold as an investment in the hope it would rise. But the only way it can rise is if still more people buy it, hoping it will rise still further. And so on. What do we call an investment scheme where current members' returns depend entirely on new money brought in by new members? ...a Ponzi scheme.
- The job of a good investment adviser is to control risk. The risks of gold can be enormous. It can potentially lose 80% of its value.[1]
- Investors owning a diversified basket of equities already own gold. Many publicly listed businesses mine gold, make products out of gold, buy, sell and store gold. The value of their gold is already baked in to their share prices. The difference between owning these businesses and owning gold is that the businesses are there to generate profits and cash flow. Gold is not.
- History has shown that there are much better risk/return trade-offs available in the market place. Even after a miserable decade in which gold had a fantastic run, the long-run risk and return of gold is far inferior to the US based S&P 500.
- The price of gold is always quoted in US Dollars. Thus some of it's rise is simply due to a fall in demand for the dollar in international markets. To the Kiwi living off New Zealand dollars the rise hasn't been quite as good.
- Where was the demand for gold in 1999? Isn’t a large portion of the reason many investors want gold now because it has gone up in price? Isn’t that why many investors wanted tech stocks and why many non-creditworthy individuals bought homes in 2005 and 2006? The urge to buy at the top will always be enormous.
- In all three cases (tech, property and gold), there was a strong underlying story that caused individuals to believe the price just couldn’t go down. With tech it was the “new economy” that will be driven by technology - there’s really no price too high to pay. That story began to appear in 1995 and 1996 yet the prices didn’t crash until 2000. With property we were told that prices only go up with no risks; even individuals without credit should get a home. With gold investment, the story is equally strong. Gold is an inflation hedge, it’s a store of value, it’s a rock to your portfolio denominated in paper currency…
- If you’re buying gold for an inflation hedge you had better really hope there is inflation. Gold has risen 500% in the past decade whereas inflation has risen only about 25%. So whatever inflation you expect is probably already priced in. In other words there’s not much hedge left for buyers late to the game. And all that assumes there will be this fantastic inflation. A good way to measure what professionals believe about future inflation is to look at the spread of US Treasury Inflation Protected Securities (TIPS) to US Government Bonds. Buying TIPS is an inflation hedge because the coupon will reset each year based on increases in the Consumer Price Index (CPI). Since TIPS are less risky (for the reason just mentioned), they are more expensive to consumers. Thus, the premium you pay for TIPS is an indication of the inflation markets actually expect. By this measure professionals expect inflation between 2 and 3%[2].
- Given the recent 500% rise in gold vs the 25% rise in inflation, buying gold as an inflation hedge at this price is the equivalent of buying really expensive shares in a company with no profits and no cash flow on the hope that, in the not too distant future, it shoots the lights out. What if it doesn’t shoot the lights out? Crash! What if it does shoot the lights out? Well in that case gold will retain its value but may not increase as much as you’d hope, because the current price already reflects that assumption. New, unanticipated shocks will be required to send the prices higher.
|
Invesment in gold: Is it still a good idea?
