July 08, 2010

Is Gold Really An Investment?

After the gold rush is the title of an article published by The Economist featuring a chart with inflation adjusted Gold prices all the way back to 1800.

Source: www.economist.com

The Subtitle "Gold is not as expensive as it seems" implies further price rises are in the making. However, the article also suggests:

“Perhaps now is the time to sell. After the January 1980 peak, the price fell by 55% over the following two years.”

So what is it then?  Is Gold cheap/expensive?  Will it rise all the way to $2,000, $3,000 or even $5,000 as some gold bugs have previously suggested?

Sorry, I don’t have the crystal ball to give you that answer.  However, we can look at a few things that are sometimes left out when evaluating Gold as an investment.

One important factor supporting the Gold price right now is the fact that Gold does relatively well when real rates of return are low and when investors typically shun other risky assets.  As long as short term rates remain near zero, the cost of holding gold is also relatively low; and with very few alternatives for higher returns, Gold will remain an asset high up on the demand list of investors.  Higher rates will do the opposite.  If and when rates will increase (any ideas as to when?), investors will increasingly seek higher risk assets and start chasing higher returns again.

But here’s the dilemma I have... Gold is often perceived as a safe-haven investment but most people forget that Gold is a commodity and it trades just like a commodity.  That means, it has no built-in returns or dividends other than price appreciation.  On the contrary, the cost of holding Gold substantially reduces returns over a longer period of time.  From that perspective, Gold cannot be considered a must-have long-term asset.  It also has a rather mixed record in terms of providing a real inflation hedge as the cost of holding gold reduces that hedge further. 

Gold does however provide a sort of feel-good or feel-safe factor.  Its luster has not diminished over the millennia and in times of economic uncertainty, the shiny metal continues to attract the weary and panic-stricken investors.  Who knows where the price of gold might be one year from now...


But investors should remember that just like any other commodity, Gold prices can move up and down rather violently. It is not all that unusual that Gold prices could rise or fall 5% or more within a day.  Long-term investors should remember this: There is a reason it's called commodity "trading", not commodity investing! 

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