Is Gold A Safe Investment?

By Douglas Rice | November 02, 2009 AAA

The price of gold has skyrocketed, and now is being touted as a must-have component of a well diversified portfolio. But if we look beyond the hyperbole, much of which surely comes from those who already own gold and want the price to go higher, we find more risk than one might think.

The Value of Gold
Gold, in its raw state, is primarily used for investment, as in gold coins or bullion, and for jewelry or other adornments. There are industrial uses, such as in electronics or dentistry, but those pale in comparison. So the underlying demand for gold is based on its investment and adornment potential. Contrast that to oil, cotton, wheat or other commodities, and it's clear that pricing gold is more about pricing the whims of investors than its use as a basic material. (Find out how commodities add both downside protection and upside potential to a portfolio, in Commodities: The Portfolio Hedge.)
Real Demand?
The demand for gold has driven the price up, and is different than the demand for other commodities - like oil - which are needed and used by all of us, in some way. The price of gold is high now, so like all other investment fads (tech stocks, real estate), people think it's great. But with little no dividends or income from interest, it's a bet on the whimsy of investors.

With interest rates near zero and the Federal Reserve fueling investors' fears, it's no wonder investors seek gold as a safe haven. But when fear falls and other investments start to look more appealing, one has to wonder if gold will still be thought of as valuable.

No Longer Linked
It's important to note that gold doesn't back our currency, and we aren't going back to the gold standard (even though some say otherwise). There is no intrinsic value to gold, as there once was. Before we left the gold standard in 1971, gold's price was set at $35 per ounce. It was directly tied to the value of the dollar, but no longer. The price of gold and the value of the dollar may have some periods where they move closer together, but they aren't linked as they once were.

Also, gold as a hedge for inflation hasn't been historically true for all time periods. Sometimes gold prices and inflation correlate; other times they don't. For example, in the early 1970s, inflation spiked but gold barely budged. Later in the same decade, gold went up with inflation. What will happen in the future to the price of gold is based more on the desire of investors to hold gold, thinking it will go up in value, than what happens with inflation.

Conclusion
Currently, the price is so high that the timing of buying must be questioned. If the idea is to buy low and sell high, buying at a nominal all time high doesn't fit. Be cautious: shiny objects can be mesmerizing. (Find out which funds make investing in gold, oil or grain an easier prospect, in Commodity Funds 101.)

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