Money Talks, So Should You

Q&A: Is there ever a bad time to invest in gold?

Kent Grealish
by Kent Grealish, The Garrett Network  (@KentGrealish)

There is never a good time to invest in gold because gold is not an investment.

Gold is a commodity not a true investment because it cannot produce a return on investment in the traditional sense. Bonds pay interest and many stocks pay dividends.

Gold not only doesn’t pay interest or dividends, it costs something to properly store, authenticate and transport gold, so owning bullion creates a negative cash flow – the opposite of a return on investment.  

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The real value of common stock can increase when a company reinvests profits in the business. As Google’s value as a company has grown so has the intrinsic (book) value of each share of Google. But an ounce of gold will never be more than an ounce of gold.

So why buy gold if not as an investment? Gold is normally purchased as a “hedge” against some risk. Generally these are currency-related risks: inflation or possible currency devaluation. But people really aren’t so much buying gold as they are getting out of depreciating dollars.

At the extreme are some people who buy gold as a store of value against some social catastrophe – the total collapse of civilization. These are the “Doomsday Preppers” of reality TV who believe that after this collapse, paper dollars will be worthless and gold will make them wealthy. Under that scenario I think lead would be far more valuable than gold – so long as the lead is in bullet form and stored in a gun.

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I think a lot of new buyers are attracted to the decade-long rise in gold prices from $300 to $1,900 and are betting that prices will continue to rise. They may give inflation as the reason, but it is my suspicion that these justifications are largely an afterthought and the real motivating factor is human nature – the lure of getting rich quick.

What really drives gold prices? Like all commodities, gold prices are determined in the short-run by supply and demand and in the long run by inflation. Since gold has limited industrial uses (jewelry and electronics) and new supplies cannot easily be delivered, it is primarily investor expectations that drive the price. In other words, gold is worth what people think it is worth.

So there may be a good time to buy gold as a hedge and there could be a good time to make a bet on rising gold prices. But invest? Never.

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PS: In 1980 Gold prices peaked at $850 an ounce and inflation was peaking well above 10%. Nearly everyone believed that at least 15% of your portfolio should be in gold to hedge against future inflation. Over the next two decades gold prices slipped to $300 an ounce. If you bought gold in 1980 and it had kept pace with inflation, an ounce of gold today would be worth more than $2,500. 1980 – now THAT was a bad time to invest in gold.

 

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Kent Grealish, CFP®, AIF® Partner in Quacera LLC, has served clients as a financial advisor for over three decades. Kent specializes in helping clients construct and manage personal investment portfolios and retirement accounts.