Gold may not be your best investment choice
You may have noticed the recent glittering surge in the price of gold. It was trading at $1,139 per ounce in early January of this year, up 30% since the beginning of 2009 when gold traded at $870 per ounce.
Historically, fearful investors have turned to gold
Prior to 1971 the U.S. operated on a gold standard, which gave gold its foundation and pivotal role as the base currency in our financial system. Since 1971, the international monetary system has been based on the U.S. dollar as the reserve currency. So the value of gold today is linked to its merits as a store of value.
Typically, when investors are fearful about inflation, political turmoil, or financial crisis, they turn to gold as a safe haven. When things calm down, normally the demand for gold subsides and the price declines.
This is exactly what happened in the 1970s. As a result,
the price of gold climbed all the way from $102 in 1972
to a peak of $850 in 1980. But then it declined in value to a low of $284 per ounce in 1985.
The short and intermediate returns have been brilliant
In the ten-year period ending December 31, 2008, gold achieved a compounded annual return of 12%. In the last five of those years, it appreciated 18% annually. These are not bad returns.
The long-term returns continue to be dull
Looking at longer term results, the case is far less compelling. From 1980-2008, the compounded annual rate of return for gold was only 1.8%, while the S&P 500 returned 10.7%. For 40 years, gold returned 8.4% (with more volatility than the S&P 500) while the S&P 500 returned 9.1% annually.
Gold is simply not a reliable hedge against inflation
In January of 1980, gold was selling at $850 per ounce
and then did not reach $850 again until January of 1998. Although the value of gold was flat, inflation rose 175% during that time period.
Adjusting for inflation, today gold would have to sell at $2,291 per ounce to be equivalent to its 1980 high of $850, and that increase would only keep up with inflation and provide no other incremental return.
In spite of the disadvantages, you may still want to buy gold
Today there are big changes in the mechanics of investing
in gold. It used to be that to buy gold, you had to actually buy either the physical metal or gold mining stocks. It is now possible to buy gold through an exchange-traded fund. Alternatively, commodity futures contracts are available for sophisticated investors to buy on margin through a commodities brokerage account.
Investment professionals view gold as a speculative rather than a long-term investment. It has a low correlation to other asset classes, and therefore offers potential for diversification benefits.
How can you invest and what are the key risks?
- Bullion yields no cash flow, and yet you must pay storage costs. Current tax law considers gold a collectible, not an investment, so it is not eligible for the 15% maximum tax rate on long-term capital gains. The maximum tax rate for collectibles is 28%. In most cases, you are not allowed to own collectibles in IRA’s or 401(k) plans. There is an exception for certain U.S. gold coins and gold of a specific purity.
- Gold mining stocks are more volatile than gold bullion because company-specific earnings could suffer from unproductive mines.
- Exchange-traded funds may not track the price of gold accurately and may be subject to additional price volatility due to hedge fund managers moving in and out.
- Futures are subject to commodity moves, which can be exaggerated and easily translate into huge margin calls.
The renewed popularity of gold will likely remain in the spotlight because its price movement has recently wowed investors. However, it remains a speculative call and appears quite misunderstood as a hedge against inflation.
For more information, please contact one of our Schenck Investment Solutions LLC advisors, or call Kathy Lakritz
at 888-556-5580 or 414-465-5557.
Kathleen A. Lakritz, CFA, CFP®, is an investment manager with Schenck Investment Solutions LLC. Kathy is based in Milwaukee, where her areas of specialization include personal investing, managing retirement plan assets, portfolio analysis, asset allocation, security review, retirement planning, and portfolio construction.
March 2010
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