Is gold a good investment?

The answer to this question depends on:

• what you want gold to do for you
• how much risk you are willing (or able) to take
• what your time horizon is 

In addition, it is important (and very fascinating) to understand what gold actually is -- not just its physical attributes but its cultural and economic importance, its history and how all of this fits into your expectation of a "good investment". 

Why gold is valuable
As a physical asset, gold is merely a chemical element with the symbol Au from the latin aurum meaning "shining dawn" and with the atomic number 79. But as a heavy, bright yellow, lustrous metal that does not lose its color through oxidization like other metals, it has always been considered an attractive and desirable material in and of itself.

Its extremely high level of resistance to corrosion made it the ideal metal for coinage and jewelry since ancient times and the fact that it is also a very malleable metal that can easily be shaped and worked into the most intricate shapes without fracturing or deforming, has made it a sought-after symbol of wealth, power and beauty throughout history. For all of these reasons, it has always been in great demand and therefore proved to be a very effective store of value through the centuries.

Modern technologies have found its properties to be even more invaluable--it is an excellent conductor of electricity, it's non-reactivity makes it ideal for many chemical and industrial processes and its malleability allows it to be drawn into extremely fine electrical wire used in sophisticated circuitry. It can easily be alloyed with other metals to modify hardness and other properties that are considered necessary in highly specialized electronics, medical, dental and industrial settings. An ounce of gold can be beaten into a micro-thin, translucent sheet ten feet wide by thirty feet long (300 square feet) and these gold foils are used widely in the space programs of the world for a variety of uses in outer space. In fact, it can be beaten thin enough to be edible and is a status symbol delicacy in a number of countries!

What drives the price of gold
Given these facts, it should be easy to understand why gold has been used as a storehouse of value and a vehicle for monetary exchange all over the world for millenia, either through gold coins or other instruments like paper money that could be converted to gold via a gold standard. But how does all of this effect the price of gold?

Of all the precious metals, gold is the most popular for the reasons enumerated above. However, its value and price depend on factors other than the simple supply and demand that govern the price of other metals.  Strangely enough, the chief ingredient in the price of this valuable metal is fear! How and why is this you ask? Well, unlike with other metals, the main demand and supply drivers for gold are not its many productive uses but the need to hoard it! That's right--most of the gold ever mined actually just sits in a vault somewhere because people feel the need to hold on to physical gold in the form of gold bullion, never allowing it into the productive supply chain. This reduces the percieved "supply" of the metal and the fear factor actually feeds on itself, allowing speculation to take over and play a large part in the price of gold.

The case against gold as an investment
The overwhelming sentiment is that gold will hold its value in the face of political and economic uncertainty and upheaval and while this has been proved to be true over the centuries, there is a new group of economic thinkers who believe that while gold is indeed a desirable asset for a host of reasons--including sentiment and aesthetics--it's qualifications as an investment are actually a house of cards that can come crashing down at any moment. A major reason for this, they say, is the decoupling of gold from money. When "money" and "gold" are no longer synonymous, the certainty of the value of the gold behind an exchange is removed.

This new belief holds that in order to have real value, gold should be tradable for productive goods and services and be accepted as such universally. Gold itself is not a productive asset since most of it just sits there in a bank vault.  Moreover, its percieved value actually makes it less likely to be used in a productive way. For example, it is considered too expensive to wire a personal computer with gold wiring even though it may be the best material for that use, so some other material is used instead. The value of gold is only as good as the perception of its value, not its true usefulness. Putting it another way, if we were marooned on an island, what would have more value--the coconut up on a tree and your skills in climbing up and bringing it down or my bar of gold? Most would doubtless say that the gold would classify as a useless piece of rock in such a situation. Besides, how much physical gold can I carry with me (it's really heavy) and how will I safeguard it? This is an end-of-the-world call.

Why invest in gold

However, the above view does not take away from the realities on the ground as we know them today and in order to determine whether gold is a good investment, we need to understand not just the facts but what we want it to do for us as an investment, how much risk we are willing to take and what our time horizon is. When we have these figured out, we then should consider the follwing three factors in making a determination:

• Gold as an inflation hedge
  One of our most important considerations when deciding on an investment to add to our portfolio is whether it protects us against the anticipated erosion in our purchasing power over time. Most likely, things will cost more tomorrow than they do today and today's $1 will buy us less tomorrow. In order to not become poor just by holding onto that $1 and standing still, we need to invest it in something that increases in value over time.  And if we want to grow our wealth, that something must increase in value faster than the cost of living. The historical record shows us that the nominal price of gold (not adjusted for inflation) has kept up with the inflation-adjusted, real value (inflation factor added) but not beaten it. And even though we are seeing a new "high price" for gold nowadays, it is really only the nominal high, not the real high which was reached in the 1980s and which would equal about $2250 in 2010 Dollars.  So based on the current price, gold has a way to go before it equals its past "high price" in real terms. And if we want to protect against hyperinflation of the kind that happens in catastrophic situations like major wars (post-WWI Germany comes to mind) then gold should more than hold its own. In the year 1900, gold was about $20 per oz which is approximately $600 per oz today when adjusted for inflation, so even if we write off the current surge in gold prices as "irrational exhuberance", it has kept up with inflation quite well.

• Gold as a portfolio diversifier
  In order to smoothen the returns of a portfolio over time, it is good practice to mix investments that have substantially different risk-return characteristics. This makes it more likely that when one asset class is down, another is up, so no one investment can sink our finances all by itself, and over the long term, we should be able to maximize returns while reducing risk. Historically, gold prices have not been correlated with other asset class returns (like stocks and bonds) as they do not have the same drivers. This is good for diversification and gold will therefore tend to improve the consistency of returns during both stable and unstable financial periods when added to a portfolio of investments.

• Gold as a safe haven
  In times of financial uncertainty, investors are worried about the ability of debtors to pay off on a loan (credit), the availability of ready buyers for an asset (liquidity) and about prices falling due to fluctuations (market). These situations can arise due to extreme movements in the economic cycle, political crises or both. Even though gold prices will fluctuate like other asset classes over time, the reasons for price declines will not be the same and the supply of gold is relatively steady regardless of political or economic conditions. As a result, gold has historically had slightly less volatility than other asset classes like the stock and bond markets.

Gold bars for IRAs
The reasons cited above make gold a great choice for retirement plans which are long-term by nature, like IRAs. This is specially so now that physical gold, in particular gold bar bullion, is much more easily integrated in its most basic essense into an IRA, thanks to The Taxpayer Relief Act of 1997. However, rules are always changing so as always, it is prudent to consult with a qualified financial advisor before you invest.  As of writing, the allowable gold investments in IRAs were physical bullion gold bars that have a minimum of 0.995% fineness along with NYMEX or COMEX approved manufacturer/assayer hallmarks and gold coins that have a minimum of 0.999 fineness and are legal tender with the exception of the American Gold Eagle which is only 0.9167% fine.  However, the South African Krugerrand with the same fineness is not approved.

Given the above, is gold a good investment for your needs? If your objective is to effectively diversify your total investment portfolio and you are able and willing to hold for the long term (10 years or more), gold can be an excellent addition to your portfolio.  Experts suggest that you should have between 5% and 15% of your portfolio in commodities, including gold, depending on your risk profile.  Conversely, gold may or may not be the best investment for you if your intention is to "make a profit" in the short term by speculating on market movements depending on the consistency of your trading luck and expertise. No matter which way you decide to go, there are several options for you to choose from ranging from mutual funds, ETFs and stocks to precious metals commodities, options strategies, coins, bullion and bars. Your challenge is to find out how to invest in gold in a way that best meets your own needs.
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