Going for Gold? It's Overrated

Includes: DGL, GLD, IAU
by: Andy Abraham

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.