As prices spike, long-term investors should exercise caution.
These days everyone from mutual fund managers to pitchmen on late-night infomercials are touting the notion that gold is a great investment. That's not unusual for an asset whose price has jumped by about 25% since the beginning of the year. In fact, on a nominal--aka, pre-inflation adjusted--basis the yellow metal is, at around $1,100 an ounce, trading at its highest price ever.
As is always true during a bull market, the case for the asset whose value is rising sounds pretty convincing. With gold, that includes a performance that has outpaced the 20% gain in the S&P 500; a history of doing well in times of inflation, as some fear we will soon enter; and a solid store of wealth amid a rapid tumble in the value of the dollar.
With all that, and the TV pitchmen behind it, it's understandable that many investors are wondering whether they should follow the herd. Here are few things to consider before you make gold a part of your investment portfolio.
First, it's important to bear in mind that, beyond its beauty, gold is not a very productive resource. It is neither a major input in manufacturing or a generator of income. Almost all the gold ever found on the earth is still sitting around, in forms ranging from wedding rings to bullion in central bank vaults. Its value, in other words, is largely contingent on what someone else is willing to pay for it.
"Gold itself is fairly worthless. Other than looking pretty and being in jewelry, it has no industrial use," says Rick de los Reyes, an analyst who covers metals and mining for T. Rowe Price Group.
Is gold a good store of wealth in troubled times? That's a common claim.
"It's a great hedge against a lower dollar," says Tom Lydon, the head of Global Trends Investments, which manages approximately $75 million in client assets. He points to increased government spending and low interest rates as reasons why he thinks the value of the dollar will decrease further. He may well be right, and there is in fact some evidence that gold does well when the dollar suffers. But currencies tend to be zero-sum games over time, and gold, arguably, is a lousy store of wealth.
While investor sentiment has driven the price of gold above $1,100 recently, it would have to double again to $2,280 to match the inflation-adjusted high of $830 it hit in 1980.
Nor is gold the only commodity to have shot up over the past year. Silver, as tracked by the iShares Silver Trust, is up 80% from a year ago, and copper, as tracked by the iPath Copper ETN is up 65%.
Frequent traders are jumping into gold and other metals because they see it as a momentum play. That's one reason why exchange-traded funds that track gold, like the SPDR Gold Trust, have become so popular. Some traders are also buying up the stocks of gold mining companies, like Barrick Gold Corporation and Newmont Mining Corporation, and gold mining ETFs like Market Vectors Gold Miners.
But even many gold bugs who recommend the metal to short-term traders admit it shouldn't be a big part of the assets you're trying to grow for retirement. Like any hot investment, the fact that the price is going up leads people to buy it, pushing the price even higher until it reaches a peak and, if history is any guide, then proceeds to plummet. Think of tech stocks in 2000 and housing more recently.
"If you're a long-term investor, gold or any other commodity should only make up between 5% and 10% of your holdings," says Lydon. He recommends that long-term investors who want to own commodities buy an index like the iShare GSG Commodity Index, which includes holdings in metals, agriculture and energy.
Harry Milling, an analyst who covers precious metals for Morningstar, seconds the 5% figure. "The point of investing in gold is diversification," he says. Gold typically has a low correlation with the price of equities, making it a way to hedge against ups and downs in the stock market, says Milling. As fear has ebbed this year, of course, investors have enjoyed a rare bull market in both stocks and gold.
As for trying to time the gold market, Milling says investors will be no more successful than anywhere else.
"You're doomed to fail if you try (market timing), especially when it comes to the infamously volatile world of commodities," he says.
(David K. Randall, Forbes.com)