Going for Gold? It's Overrated

I am sure many people “think” they know what fate awaits gold in 2008. Unfortunately, my crystal ball is not plugged in, nor has it worked in the past. I believe anything can and will happen. Prudent investors analyze the facts, and look to take fear and greed out of the equation.

Several short months ago, gold was making front page news with its reaching a 27-year high of $835.20 an ounce on November 8. However since then, gold has struggled. It closed Friday at $793.30 in New York futures trading. Any value investor could easily say gold was a great buy at $370 or $400 dollars an ounce. Surging oil prices also have helped push gold up in recent years by fanning inflation fears. So many other commodities are moving at bull market speed (wheat, soybeans, and even rice, the staple for most of the world). Last week in the markets the PPI report came out and showed inflation growing at 3.2%.

However, gold - considered the proverbial inflation hedge - fell. It leaves one questioning the possibility of gold advancing. There were articles after articles proclaiming that gold will go to $1,000.00 an ounce or even more. Anything can happen, but when good news came out for gold and it fell, one needs to possibly reevaluate the situation.

One can stipulate that gold fell because the U.S. dollar gained strength. The weak dollar for the last two years had been one of the impetuses for gold. Gold in the past has gained when paper currencies weaken. Furthermore, because gold is priced in dollars worldwide, the dollar's slide in effect made gold less expensive for foreign investors whose currencies were strengthening. Part of the Indian culture is gold jewelry, and the rise of the rupee versus the U.S. dollar made gold even more attractive to the massive Indian population.

I have yet to meet a successful investor who has followed the front page of any newspaper for his or her investing research. Actually I have met (and consider myself to be) the antithesis, who looks for ways to invest in the opposite direction. Over the years, gold has not been a good investment. Actually over the past 200 years, its returns have barely kept up with inflation. Its dismal returns negate any benefit the portfolio receives from so-called reduced volatility. Furthermore, if one holds gold physicals, they would incur an additional cost which would lower returns even further. However, nothing ever feels better in one's portfolio in times of crisis, or uncertainty, as gold. The Doomsday Fear of an economic collapse can easily overcome the rational.

We are at a very interesting and volatile time in the context of the world’s economies. No one has a crystal ball, but prudent investors might want to consider diversifying to a small degree on a further decline on gold. According to the Fibonacci sequence, a break below 732 would leave the up move of gold into question. Markets always have a way of surprising us and reaching levels we would never expect. I find it hard to believe that the secrets of long-term successful investing would be on the front page of virtually every newspaper. When one invests, one needs to ask oneself 'How much will this cost me?' to see if it will work. Quantify the risk and the potential loss, and simply put the position on. No one has a crystal ball, but if you do consider yourself a value investor, you might want to ask yourself why you didn’t buy gold at $400 an ounce.

Comments

[Jimk7]

Wasn't gold this high around 1980? I think it only goes high when oil does. We will probably see it go back down to where it likes to be which is around 400 +/- once this whole globalisation fad kicks overs.
I'd only expect it to reach true value to inflation (2,000+) if our planet's environment begins to crash or the U.S. economy goes bust.

[Ron Paulitan]

If you consider the long term fundamental, purchasing gold is the prudent thing to do. We have trade and budget deficit. The subprime mess is just a tip of the iceberg. Consider other shady loans such as option arms, piggyback mortgage, etc. Consider the government intervention to this mess. We have big banks like Citigroup or Washington Mutual having problem maintaining capital ratio. How do you mark gold off because of its short term movement? I think it's you who's not doing the due diligence.

[teraflop]

I cringe thinking of my current gold position with its negative yield. However, I picked it up last year in anticipation of what we have sitting on our plate: (finally) realized/acknowledged inflation expectations along with structural weaknesses that people only can see when it comes to USD FX changes and housing.

My view on inflation back then was: oil is up, real estate was up, gold was already up, commodities were up - why is there "no inflation?" *There* was your inflation. And as in any under-priced/suppresse... process, when it comes to pass, there will be a hockey-stick like move upward. My decision was contrarian, as I am not a Gold Bug (Gold is just one of several assets I have) and only a few economists that I know of were complaining about the traditional measures of inflation.

Looking forward, I agree with you, many expect >$1000 prices which is an indicator in and of itself. As for where we'll go, I would even ask the question, what did Gold do during the Great Depression?

[misterchan]

There are many negative voices like yours. I bought gold under $400 and my investment has tripled. Also, my stock portfolio is heavily weighted in that direction and also in basic resources. I will get ready to sell when everybody wants to buy. Which has not happened yet.

[Andy Abraham]

I do not think my point was taken... firstly the trend is up until or if 732 is breached... with that said... I am extremely concerned about the banking crisis and all the ramifications potentially on the horizon...but with that said... when the proverbial inflation hedge falls on good news... one needs to take note...as well as when newspapers are touting an investment idea... the risks to the trend are greatly enhanced...

[John B]

Andy - What is your view about the Interventionals please?

www.financialsense.com...

Thanks

[GaryD]

Gold is not an investment, it is a hedge (insurance policy) against inflation. A well run gold miner with low extraction costs and high cash flow is an investment. As an insurance policy, it is pretty good since it's value does not go to zero at the end of the term.

[Lorelei]

You say "Over the years, gold has not been a good investment. Actually over the past 200 years, its returns have barely kept up with inflation."

All you have to do is compare what inflation did to the purchasing power of the dollar since 1970 to see that gold is a very good deal indeed!