The Love Affair With Gold

By Tim Parker | February 14, 2012 AAA
The Love Affair With Gold

Sometimes you can't help but laugh at the markets. Remember the dark days of December when gold made its way down to below $1,550 per troy ounce? If you were following the market along with the analysts' commentary, you remember the almost apocalyptic tone of the commentators. Sell your gold now, they said, because it's in free fall. Others were saying that there was no floor to the price in sight and we could see another $500 come off in a relatively short amount of time.

SEE: Getting Into The Gold Market

Then, something very different from the analysts' commentary started to happen. It was something that very few predicted. Gold started going the other way. Now that we're into February of 2012, gold sits comfortably above $1,700 per troy ounce representing more than a 9% gain since the end of December. Does that mean that we're once again in the clear and gold will continue its climb higher?

How Gold Acts
Gold might be the perfect tale of three personalities and that's a problem for investors. One personality is that of a commodity. Commodities like oil, grains and even orange juice, are supposed to trade largely on supply and demand with a dose of speculation. When Iran threatened to close the Strait of Hormuz, the price of oil went up. When a few days of cold weather in Florida damaged the orange crop, orange juice futures went up. Commodity traders understand price action like that, but gold barely responds in either direction when supply and demand stories break. Getting gold out of the ground is becoming increasingly more difficult, but we rarely hear that as a reason why gold has hit such high levels in the recent past. (To learn more, see How Does The Strait Of Hormuz Affect My Gas Prices?)

Gold also acts as a currency. We've all heard of the gold standard and although there isn't enough gold in the world to ever run the world's economies on such a system, it still reacts as if it's a currency. Recently, the Federal Reserve announced that it would keep interest rates low through 2014. As soon as the news broke, gold rallied.

Finally, gold acts as a stock. The textbooks tell investors that gold is a good way to protect capital in a falling market making it a hedge for traders. Stock pickers have written books about how a well-diversified portfolio should have gold as a holding to protect against stock market downturns, but gold hasn't behaved that way. Since October of 2011, gold has moved in the direction of the stock market making it an ineffective hedge. What made it shift its behavior in October? Why does it now act like a high beta stock instead of a commodity?

Should I Invest?
The many personalities of gold make it tough to hold in a portfolio, although many experts still believe that investors should have gold as an equal weight holding. Many of those same experts will provide a forecast, along with well thought out reasoning as to why gold will go in a certain direction, but the truth is that nobody knows.

The Bottom Line
As the past couple of months have shown us, when gold starts to fall, the bulls quickly become bears and when it rises, they go change their outlook yet again. Investors like Warren Buffett advise people not to buy in to something they don't understand and although gold might have a lot of upside, there's no doubt that it's difficult for even the most seasoned investor to figure out.

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