By Kevin M
Does a day go by when it doesn’t seem as if the towers of financial and political power seem to be shaking some where in the world? Iceland, Ireland, Spain, Greece, Portugal and now Italy. Will the Euro implode? Will the dollar implode? I personally don’t think either will, but given the perpetual avalanche of news that no one seems to be able to pay their bills, this is not a time for idle speculation.
And here’s what we do know…interest bearing investments (CDs, money markets and treasury bills) have gone negative against inflation…bond yields are at all time lows and since bond prices run in inverse proportion to rates, when rates do begin to rise, bonds are poised to take a big hit…stocks are swinging wildly in a way that suggests that a tumble of epic proportions may be in the offing…and real estate is already down for the count.
Against this backdrop the most reliable investment of the past ten years has been gold. Even with the correction since August, the price of gold has risen on the order of 500% during a decade when nearly all other investment classes have either tanked or gyrated wildly to no advantage.
Gold—after a 500% run up? That looks like it could be a bubble. Or it could be a sign of the times. A bubble is caused when buckets of money flow into an investment regardless of fundamentals. What has to be considered in the case of gold is that it’s an asset that performs best in a dysfunctional environment. I think that about sums up where we’ve been at for a few years now. Because of gold’s unique relationship to the rest of the economy and financial spectrum, we have to say that gold’s price is in line with its “fundamentals”. It’s an asset unlike any other.
If you think now is a good time to buy gold, there are different ways to buy and hold it.
Each has its own advantages and drawbacks. How you decide to hold your gold then will have more to do with personal preference than anything else.
Gold exchanges and ETFs
One easy and low cost option is to invest through a gold bullion exchange, such as BullionVault that stores your gold remotely. Not only is this a more liquid way to own gold (easy buying and selling) but it also solves the storage problem and does so with a high degree of safety.
Exchange traded funds, or ETFs, of which SPDR Gold Shares (GLD) is the largest, are another way to go. Like bullion exchanges you don’t have to take custody of your gold, and you can easily buy and sell positions as you like, though the fees tend to be somewhat higher than bullion exchanges.
Gold coins
The most direct way to own gold is with gold bullion coins. There are advantages and disadvantages to holding gold in coin form, and these should figure into any decision to own it.
Advantages:
- It’s close to the only investment you can hold in your hand
- You always know exactly what you own
- You never have to concern yourself with the financial health of the custodian—you are the custodian
- In the event things get REALLY ugly, it could be the safest of all assets
- Though one ounce coins (Maple Leafs, Krugerrands, Eagles, etc) are the most common, there are also smaller denomination coins available
Disadvantages:
- Gold bullion pays no interest or dividends
- Transaction costs, on both the buy and sell side, are high
- Holding the coins places the risk of loss squarely on you; you can have them insured, usually through homeowners insurance, but that will add to the cost
- They aren’t terribly liquid–you can’t cash them at a bank or use them to buy gasoline or groceries
- Because of their high value they are probably unsuitable for barter in a complete economic meltdown
Gold stocks
One of the problems with most forms of gold ownership is that it’s not an investment in the true sense—it doesn’t represent the means of production (future cash flow) and, as mentioned above, it doesn’t pay interest or dividends. What gold is mostly is a store of value, a safe haven in uncertain times.
Not so with gold stocks however. Gold stocks are a play on the present and future cash flow of gold mining companies, and they DO often pay dividends. They can be a spectacular way to play a rising gold market.
Or not.
Gold stocks aren’t a perfect hybrid between the store of value of physical gold and the investment potential common to stocks. They’re mostly a speculation of the highest order! Not only are they subject to all the economic and financial constraints of every other operating business out there, but they tend to operate in remote and dangerous parts of the world and/or in highly uncertain regulatory environments.
If you plan to take a position in gold by buying gold stocks, it should be only the smallest sliver of your overall portfolio. The upside potential is meteoric, but the downside risk is there in equal measure.
Watch your allocation!
We have to remember that gold is not a play on economic growth, which is the more common (but never guaranteed) state of affairs. Gold has a place as a store of value, but it isn’t an investment (with the speculative possible exception of gold stocks). It shouldn’t be seen as a get-rich-quick play, but rather as part of a capital preservation plan.
All of that argues for a relatively small position to invest in gold.
Right now I’m of the opinion that most of our money should be in cash type investments, to be positioned to take advantage of market downswings. But a 10-20% position in gold can make that cash position even stronger, which means that gold merits some investigation—and maybe even a buy.
OK, the price of gold is high, at least in nominal terms—do you think now is a good time to get into gold? Why or why not?
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A View From the Economic Cliff
Hi Kevin,
Great article!
You ask, “OK, the price of gold is high, at least in nominal terms—do you think now is a good time to get into gold? Why or why not?”
Our answer: Yes and no.
Yes. If we didn’t have any gold, as an insurance policy against political mischief and an out of control government, we would begin immediately a logical program of buying it either on the dips or by averaging in over time until we had, at a minimum, a 5-10% position in physical gold. Until such an allocation was achieved, we would feel underexposed to gold and underinsured against political calamity. We would view this portion of our net worth simply as insurance. The price of gold may go up and down, but the protection it provides remains relatively constant to the prevailing market risk and other assets in the portfolio it was designed to protect. As such, this allocation is immune to the inflation/deflation debate. People don’t cancel their home insurance during periods of seemingly lower risk from fire danger, or weather related phenomenon, and neither should they go “naked” with their financial houses. Insuring our lives, homes, vehicles, and financial portfolios is absolutely essential to sound financial planning.
No. We feel an allocation, in gold, above 5-10% of our net worth becomes speculative in nature and therefore enters the realm of being a price sensitive exercise in due diligence. No one knows the future. We can speculate about the future, but we, nor anyone else, know for sure what the future will bring nor when. The exercise in due diligence, pertaining to financial speculation, involves assessing the probabilities of group behavior patterns emerging over time and placing financial bets accordingly. Fundamental and technical market analysis help assess the probabilities of the ‘what and when’ related to human behavioral tendencies.
The financial contagion going on in Europe is putting downward pressure on the Euro and upward pressure on the dollar. This has created the illusion of the dollar being, fundamentally, a sound currency and a safe haven for capital flows. Market illusion speaks and we listen simply because we respect the human behavioral tendencies that drive markets. Fear and greed also drive markets and a commonly used mechanism for overexciting these human emotions is the media. It would appear financial shakers and movers use the media to channel human emotions in a direction most desirable to their ends. Although we don’t believe financial shakers and movers actually control the direction of markets, they do have the capacity to augment and magnify the given trend for their advantage via the media.
If the beauty of the Euro could be described in animal terms, we are tempted to first think of a hippopotamus. A healthy and prudent comparative description of the Dollar, in such terms, is that the Dollar is prettier than a hippopotamus. Not exactly a flattering comparison, in our view, but a far more useful one than holding to the mainstream media propagated illusion of the dollar being pretty and sound on a fundamental basis.
As long as the illusion remains that the dollar is fundamentally sound and a safe haven for capital flows, there will be general downward pressure on gold. The up and down and generally sideways action in gold corresponds directly to the on-again/off-again media attention on Europe. When the media focus is off of Europe, gold climbs. When the focus is on Europe, the dollar climbs. If this continuing European fiasco brings us another 2008 styled economic crisis, it should represent another great opportunity to load up on speculative gold and silver positions.
When the bond raiders are through with Europe, they will turn on the U.K., then possibly Japan, and then the U.S. The mess that had its origins here in the U.S., as the result of the dollar being the reserve currency of the world, will ultimately end here. When the masses begin seeing the Dollar as the proverbial Emperor who is wearing no clothes, many of them will be enticed to chase a much higher gold price ever higher. We hope to be selling some of our speculative gold positions to them. In our view, that day is a ways off. A good way to substantiate that viewpoint is by taking a poll of 100 persons and determining how many of them even have gold for insurance let alone speculation. This exercise, alone, should serve to quell any speculation that a bubble has formed in gold.
Steven and Debra´s last [type] .."Everybody Knows" the Debt Deal is Rotten
Hi Steven and Debra–I agree with all that you say. A gold position should be a relatively small slice of your portfolio right now. A small position could insulate a portfolio against major political and financial upheaval, but too much could be overkill. My thought is that as finances in Europe unwind, money will stampede into dollars. This will strengthen the dollar and could last for a couple of years. As weak as the dollar is, it is still the reserve currency, seen as a safe haven relative to other paper assets, and more importantly it’s the primary currency to settle debts with. That last one all but guarantees it’s value, at least at some level.
While the situation deteriorates in Europe, no one should bet against the dollar. It’s almost as if US fundamentals won’t matter for a time. As I wrote in the post, cash equivalents should be the largest share of a portfolio right now. But a position in gold will represent a diversification–or insurance as you say–making the portfolio stronger overall. The question then is how to hold it. That will depend on personal preferences.
Gold for safekeeping is smart – especially with where the economy is going. Not where you are going to make money, mind you, but just one method to protect it.
Olivia Hmelnitsky´s last [type] ..Goldsenze
Hi Olivia–I tend to agree. From what I can see, gold looks more like a capital preservation asset more than one to make money with. It should occupy a small percentage of your assets, with most of the rest going to wealth building assets. Still, capital preservation alone merits having some.