Should I Invest in Gold?
The last several blog posts have been about ideas and concepts regarding how to intelligently and simply invest in the financial markets. I thought I would take a break from talking about the financial markets and spend some time discussing alternative investments (i.e., besides stock and fixed income investments). One question I have heard a lot lately is, “Should I invest in gold?” In this post I will give my thoughts on precious metals.
First of all let me say that, in my opinion, buying any precious metal like gold is not an investment; at least not in the traditional sense of investing in the financial markets. The reason I say this is any commodity such as gold, oil, raw land, etc. does not have any business fundamentals to evaluate such as income, expenses, debt load, product market share, etc. When you buy commodities, you are really just betting on their future demand.
Having said that, at this point in time, I think it does make sense to own some commodities and precious metals. I believe this because currencies the world over are being devalued. There is no doubt that most central banks in the developed economies are increasing their money supply in order to combat potential deflation due to the large scale consumer debt de-leveraging that is occurring. The US Federal Reserve has been one of the worst offenders. Currency devaluation is one main reason why, in the last year or so, we have seen the price of most commodities rise significantly in US dollar terms.
Owning precious metals or other commodities such as petroleum is a hedge against the increase in cost of these items due to currency devaluation. More to the point, I view owning precious metals and commodities as insurance policies. I own them because I do think they will continue to increase in price, albeit in an unpredictable manner. Nevertheless I hope that I am wrong and that they go down in value in the future. I hope this for the same reason I hope I never have to make any insurance policy claim. When you have an insurance policy claim, it means something bad happened. I am sure you are not hoping to make a claim on your home or auto insurance policy. I view precious metals and commodities the same way. That is, if the price of gold or petroleum goes up significantly from here, that will mean the rest of the economy and my investments will be doing badly. So I hope gold does not increase from today’s price (about $1,500/oz as of this writing). However, looking at the debt burdened western economies and the US debt level in particular, I do think the gold run is not over and that gold and silver are going higher from here. How much higher is anyone’s guess.
Why do I think this? Historically, when nations get as far into debt as they are today (Read this earlier post on the US government’s debt and unfunded entitlement liabilities), the easiest way out of this situation (for the politicians) is to “inflate” the debt away through currency devaluation. I don’t know how or when this will happen, but I am pretty sure it will happen in some capacity. When it does, your financial assets (i.e., your stocks and bonds) will lose purchasing power in real terms even if their nominal prices increase. But your hard assets like precious metals and commodities that the government cannot devalue should increase in value in real terms and maintain their purchasing power. That is the hope anyway.
One other thing to keep in mind about gold. Gold is a very good hedge against economic chaos. In the near term a Greek debt default scenario, which is looking more likely by the day, I think would qualify as a chaotic event as this could act as a domino effect on other financially troubled European nations.
You are probably wondering how much gold you should own. This is a source of much disagreement. Some Wall Street money managers think you should not own any precious metals. Many money managers think metals are a non-productive asset that you should not waste any capital on. I heard this a lot when I bought most of the gold I own in 2007 at between $600 and $700 per oz. I have noticed now in 2011 at $1,500 per oz. I am not hearing this line of thinking from Wall Street as much. Most investment managers now agree that owning some gold and/or silver bullion does make sense.
Alternatively, one of my investor newsletters last year (2010) was so sour on the world markets that they were recommending having around 20% to 25% of your assets in precious metals. They are obviously fearful about the future world economy (in my opinion, there is good reason to be fearful). That newsletter recommendation could end up being correct. But I just cannot bring myself to own that much. Having 25% of my financial assets in precious metals would significantly reduce my current income and would introduce too much volatility to my portfolio. And, in any case, my feeling is if you have more than 10% of your assets in any one sector, you are starting to become a speculator.
So what have I done? I currently have about 8% of my financial assets in gold and silver bullion. I buy them through gold and silver ETFs (stock symbols GLD and SLV). I may increase my allocation in the near future but I will not have more than 10% of my financial assets in precious metals and commodities in total.
If you do not own any gold or silver now and think it may be a good idea to have some exposure to precious metals, I would not buy my entire allocation all at once. Metal prices are very volatile. Let’s say you decided to dedicate 8% of your portfolio to precious metals. I would dollar cost average into the sector over the next several months; perhaps buying 1% per month for the next 8 months. I do think gold and silver are going higher from here, but they may go lower before they go higher.
That is my view on owning gold. One last note; my 8% precious metals allocation is part of my 40% equity allocation. I am still holding 60% of my financial assets in fixed income instruments (cash, money market accounts, bank CDs, and short term bond funds). This is what I feel comfortable with right now. Everyone must decide what portfolio make up is best for their own personal situation.
Next up on the retirement planning agenda: REAL ESTATE.
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