Fundmastery Blog

Kurt Brouwer September 14th, 2007

I get asked about gold periodically, usually by someone with a gleam in his eye. I say his eye because it’s almost always a man who asks the question. I have no idea why investing in gold is a guy thing, but in my experience it is.

I think most people considering gold may be unaware of the sad history of gold as an investment. In fact, it is quite a paradox. For example, gold is currently at $707 oz., which is almost triple its value from 2001, yet gold still has not reached its historical peak of $875, which was set in January 1980. Admittedly, that peak was a very short-term one and gold quickly settled back down to $700 or so later in 1980.

My experience with gold dates back to the early 1970s when I bought some gold and silver coins along with Swiss francs. I was 23 and getting interested in investing even then. The arguments for gold today are pretty much the same as they were back when I bought in. They really have not changed much in the intervening 34 years. I have, but that’s another story. The pitch for gold goes something like this:

The dollar is losing value because the government is justing printing money that is not tied to anything tangible like gold. Gold has been a storehouse of value for thousands of year. Stocks are risky as are bonds, but gold is a hedge against future inflation. Our government is piling up huge amounts of debt that can never be repaid and foreign governments–China in particular–own so much of our debt, that they could decide to collapse our economy by selling Treasury bonds and moving the cash to the yen or some currency other than the dollar. Gold is also a tangible asset that will be worth something if the economy collapses etc.

If you are interested in gold, you have probably heard something along this line. If you have, please stay tuned because almost everything in the paragraph above and in the argument for gold is either false, overstated or completely irrelevant.

For example, the claim that our government debt is high are silly. U.S. government debt of nearly $9 trillion is about 66% of our Gross Domestic Product (GDP). This ratio is lower than those of Japan, Canada, France and Germany for example. And, of that $9 trillion, about 45% is owed by the government to itself. About 28% is owned by U.S. citizens and permanent residents. Only 27% is owned by foreign entities, primarily governments. The number one foreign government in terms of ownership of our debt is—Japan at $612 billion. China is next at just over $400 billion, which is under 5% of our total government debt.

These issues of government debt and the strength of our economy have been covered many times on Fundmasteryblog, so I do not want to digress too much. However, if you are really concerned about these issues, go here and here. For great information on U.S. government debt, go here. For a few investment tips, go here. If you do read these stories I have linked, I think you will feel much better about our economic health.

Sorry for the digression. Let me give you my story as an investor in gold. I first bought gold in 1974 at about $150 oz. I had heard all the arguments noted above and, in fact, inflation was a serious problem in that decade. In addition, stocks tumbled throughout 1973-74 as did real estate. We experienced the first oil shock due to the OPEC embargo, so it was a difficult time to be an investor. Going into the decade the price of gold for U.S. investors was fixed at $35 oz. When the government price cap was lifted, the price of gold began to soar, reaching the peak mentioned above in 1980.

I rode gold up to over $400 oz. when I sold it to my Dad because I needed some cash and he wanted gold. I literally did ride it up because I owned a bicycle then as my primary transportation and I pedaled across parts of the U.S. and Canada with my gold sewn into the lining of my bicycle panniers. My Dad held the gold until it hit $800 oz. and then he sold it to another investor, so my family’s timing was good. We got in at a good time and got out at a good time. This theme of trading in gold will be repeated, so stay tuned.

Shortly after my Dad sold out, gold headed south and lost almost half its value in a year or so. And, the price of gold has still not hit its 1980 high point–27 years later. Is gold a good storehouse of value against inflation? Well, gold is currently at $707 oz. If it had merely kept up with inflation since the high point of 1980 it would be over $2,000 oz. If you want to check my math, go to this handy calculator provided by the U.S. Bureau of Labor Statistics.

Now, if someone wants to put 5% of their portfolio in gold coins and they can do so without paying a huge commission, I really do not have a problem with that. Or, if you are a trader and you want play in the gold market, it could work for you. Not my cup of tea, but that’s fine. Before considering gold though, you should decide if you are a trader or an investor. If you are a trader, gold is just as suitable (or unsuitable) as any other commodity. Pay attention to trendlines, keep your trading costs way down and hope you get out before it cools off.

If you are an investor, I have two thoughts. As I mentioned earlier, if you like the feel of gold coins and want a few percent of your portfolio in coins, no problem. However, if you are doing this as a hedge in case the economy collapses, you better be very careful. Buy in small denominations as it will be hard to get change if the economy ever did collapse. Also, buy a shotgun because once you start flashing gold coins around, you may need one.

If you are really are considering gold as a long-term investment, then I suggest you consider these two charts. First, the Dow Jones Industrials (30 well-known stocks) since 1980 and the second, which is gold, also since 1980. Click to enlarge:

Source: Stockscharts.com

Now, please do not get me wrong. I am not predicting that either gold or the Dow will perform over the next 27 years as it has over the past 27. In fact, one of my friends asked me about gold a year or two ago and now he claims he did not invest because of my negative stance on gold. As I pointed out, even though it has gone up quite a bit, he was not planning to invest much and, after transaction costs, the whole deal would not have exactly changed his lifestyle. More likely, he would have made enough to go on a nice weekend retreat somewhere.

I am not predicting gold’s demise nor am I saying it cannot go up. However, if you are thinking about gold, I would hope that you put in context the claims and sales pitches given out by the gold bugs. Have you ever seen a purveyor of gold hold up the chart above. I doubt it because it is a tale of futility in owning gold.

Update: Welcome to readers of the Wall Street Journal’s MarketBeat Blog and of US News’ Capital Commerce blog. If you liked this post, bookmark the site for information on investing, hedge funds, mutual funds, the economy and much more. Here are three posts that have been popular:

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