Should You Invest In Gold?

For centuries, mankind has been obsessed with shiny pieces of metal known as gold.  Even today, investors the globe over often flee to gold in times of economic instability because it has often functioned well as a hedge against inflation and a falling currency.  True to form, gold has been on a tear of late, having slightly more than tripled from $300 per ounce to over $900 per ounce over the past decade with no sign of slowing down.  So, should you buy gold?  Some people think so but I myself am skeptical.  To that end, I’ve compiled a list of the pros and cons of investing in gold.  First the pros.

Pros of Investing In Gold

• The dollar is likely to continue depreciating for the foreseeable future.
• Inflation is likely to accelerate at least slightly over the next few years if not longer, benefiting the owners of all commodities and raw materials, including gold.
• Demand for gold for industrial purposes seems to be rising.
• Gold returns, like those of other commodities, are usually uncorrelated with bond, stock, and real estate markets, making it a good diversifier in times of economic turbulence which can sometimes lead to higher returns with less risk.
• It’s a physical metal with intrinsic economic value and various industrial uses, unlike fiat currency.  What that means is that while the value of gold can certainly fall, it can never go to zero, unlike the US Dollar, Euro, or any other fiat currency.

Cons of Investing In Gold

• Gold does not pay dividends, interest, or create real economic value.  It sits in its vault collecting dust.  Stocks, by contrast, represent ownership in a living, breathing company with the ability to create and destroy real economic value.  Gold will not and cannot beat the best stocks over the long run because good stocks come from good companies that create real wealth where there was none before.  No matter the economic circumstances, there will always be some companies that thrive.
• In 1808, an ounce of gold would have bought a good mens’ suit.  In 2008, an ounce of gold would have bought a good mens’ suit.  Over long stretches, gold is good for maintaining purchasing power, not increasing it.  Unless you have impeccable-enough timing to consistently buy at the bottom of bear markets and sell at the top, you are extremely unlikely to gain wealth over the long term with gold.
• Gold prices are notoriously hard to predict.  Since gold does not create long-term value, timing is of the utmost importance.  Unfortunately, it’s nearly impossible for many experts to buy at the bottom and get out in time.  What chance do most amateurs have?
• Gold is a transmutable metal, meaning it isn’t consumed but only changes form.  Thus, all the gold ever mined is still in existence today.  Furthermore, more gold is being mined every day, increasing the global supply.  If the supply of gold grows faster than global inflation, gold will likely lose value.  For what it’s worth, I think this scenario is highly unlikely.

So Should You Buy Gold?

The short answer is no, but let me explain.  I don’t think most investors would do well owning actual gold (bullion, coins, shares of gold bars in a vault somewhere) for several reasons.  First, gold doesn’t pay dividends.  It sits there.  Second, gold has storage costs, so not only does it not produce any income, but it requires you to regularly put up more cash to care for your investment.  While this may be small, it can make a big difference in certain situations.  That said, gold, like most commodities, is a good diversifier and in my opinion deserves a small place in most portfolios, but only a small one.  I don’t recommend more than 10% of an investor’s portfolio be in commodities, and gold should probably not make up more than 20% of that allocation.  If you insist on more exposure to gold, I highly recommend buying stock in mining companies rather than holding the metals itself.  Mining companies create real value and generate income, which is a significant advantage.  They also tend to be at least moderately leveraged, giving you more upside (and downside) in the event gold rises sigificantly.   One popular gold-focused ETF is SPDR Gold Shares (GLD).  Vanguard’s excellent Mining And Precious Metals (VGPMX) mutual fund is unfortunately closed to new investors but I would recommend it were it to reopen (which it may in the future).

For more information on commodities investing in general, I highly recommend Jim Rogers’ seminal book Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market.  Rogers presents a strong case for a long secular bull market in commodities.  Indeed, much of what he predicted in the book several years ago has already been happening.  There’s still plenty of time to get in at the bottom, though, because commodity bull markets tend to last years, if not decades.