Should I Invest in Gold? Pros and Cons of Precious Metal Investing
Few commodities can create the excitement that compares to ‘gold fever’. The price of gold has rocketed over the past years. Should you buy gold or pass on it? What are the pros and cons of such an investment?
1. Portfolio Diversification
- PROS: If you purchase a large group of similar assets, you will be prone to momentum problems. A wave of interest in your favorite sector could drive all of your shares up, but if the group becomes out of favor you may see all your stocks drop. Diversifying removes the ‘swooshing water in a bathtub’ effect and stabilizes your portfolio against fads and trends. Gold has a low correlation to other commodities in general, and can greatly diversify your portfolio.
- CONS: Gold is trading at historical highs. The high volatility and high valuation of gold increases the risk factor. Diversification is good to a point. Holding physical fruits and vegetables would also create diversification, but spoilage could quickly occur. Similarly, the benefits of diversification need to be weighed against the high speculative value and the potential for price spoilage.
2. Bullish Forecasts
- PROS: Some are forecasting higher prices yet. They claim that as the US dollar raises interest rates, this will boost gold prices. Some think $2,000 or even $5,000 is a possibility. If this were to happen, you could profit from such a move.
- CONS: The larger the climb the father the downside is. Gold is trading above its long-term historical averages. Is this the new price of gold or is this a high momentum cycle that will meet its end? Even if gold has more of an upside from here, the volatility makes the risk factors go way up. The speculative traders are better suited to the wild swings at this point.
3. Inflation Fighter
- PROS: Gold is viewed as a global alternative currency. When fiat currency is devalued through inflation and such measures as quantitative easing, the limited storehouses of gold can hedge this effect. Gold needs to be mined and this takes far more time than firing up the printing press for another trillion dollars worth of currency.
- CONS: Gold, as Warren Buffet likes to point out, has no utility. You cannot put your gold to use to earn you more money. If you hope to make money off gold, it is generally with the idea that someone else will place a higher value on it and give you more. This makes the price of gold open to a high amount of speculation and a range of prices that may counter the benefit of fighting inflation.
4. Gold as a Safe Haven
- PROS: Gold has the unique status as being a safe haven against disaster. If economies crumble, or natural disasters occur, few commodities are viewed as having the safety of gold. It’s a globally accepted currency that can be physically traded even if no electricity or banks were available in some post-apocalyptic disaster.
- CONS: Is this really the reason behind your purchase in gold? If so, you have likely already prepared for a global crisis. Having a usable currency after a global disaster is a start, but you’ll also need to protect your wealth with weapons, have a supply of non-perishable food, and a shelter to live in. If this isn’t what you had in mind as a safe haven, then you are likely coining the phrase to add weight to a bullish forecast. A safe haven investment only finds its true value in massive disasters. If you are not banking on that, the safe haven status might not be the driving force behind your desire to purchase gold.
5. Growing Demand
- PROS: China’s and India’s demand for gold is insatiable. Notice the growing demand: China bought 207 tons in 2000 and this is up to 579.5 tons in 2010. India bought 855 tons in 2000, and 963 tons in 2010. As the wealth of India and China goes up, the demand of gold will no doubt increase
- CONS: As gold becomes popular in the form of exchange traded funds and a host of other bank backed investments, the view might shift from jewelry to investment. Jewelry is an important aspect of gold buying since, like diamonds, it is held for long periods of time. If gold loses its precious metal luster as regards jewelry in some countries, this could negatively impact prices as demand declines. This may not happen, but it’s worth considering how the status of gold could potentially shift somewhat away from jewelry.
6. Gold as a US Dollar Hedge
- PROS: Gold is listed in US dollars. If the US dollar drops, the price of gold goes up by comparison. If you are forecasting weakness in the US dollar, you can profit from this.
- CONS: This is true, not just for gold, but on any pairs on the FOREX market. You can trade one currency against another, silver against US dollars, and so forth. Just because you can trade gold against the US dollar, it doesn’t mean that it gives you the best value. There are numerous other pairs that you can trade as well. You need to also consider the US dollar but also the global valuation of gold. These two changing variables will influence the usefulness of gold as a hedge.