Despite popular opinion, I've never been a big believer in investing in gold. There's a reason gold is the currency of pirates, drug dealers and James Bond villains. I know it's smoked other asset classes in annual returns during the past decade, delivering gains of roughly 30% on average. But, like most bid-up asset classes, trees don't grow to the sky and the gold trade is definitely long in the tooth.
Up...up...and look out below
In the past seven years, the best way to expose yourself to the upward of gold has been through the exchange-traded fund (ETF) SPDR Gold Trust (NYSE: GLD).
Clearly, it's an extremely crowded trade. In fact, it reminds me of another crowded trade...
Yes, I'm talking about the venerable tech giant Apple (Nasdaq: AAPL). Only months ago, analysts were proclaiming it as the "thousand-year tech stock" that would climb to $2,000 a share and beyond.
Guess what? That never happened.
I know I'm comparing ingots to iPhones, but you can see and hear a lot of the same thought process among investors. Lots of people have an iPhone or iPad, and if they don't, then they probably want one. And because of this, nearly everyone wants to own the stock. The difference between gold and Apple is excessive optimism versus excessive pessimism.
Both can reach a tipping point.
Don't fight the Fed...
U.S. Federal Reserve Chairman Ben Bernanke has clearly stated that the Fed will maintain its monetary easing measures until at least 2015. Because of this, investors are starting to brace themselves for the "inflationary Armageddon." And as we all know, gold thrives during inflationary times. These investors say the U.S dollar will become worthless because the Fed has no intention of shutting down the printing press.
Well, that's not exactly the case.
The U.S. government is not actually putting more paper money into circulation by printing new bills. It can't do that. By law, only the U.S. Department of Treasury can produce currency. The Fed's quantitative-easing (QE) policy is pretty simple. It buys all sorts of U.S. government securities such as Treasury notes, bonds and bills to generate liquidity to the market without having to actually make money. This also keeps interest rates low, since supply of these assets is tight.
The Fed's objective is twofold. Now that the banks have vaults full of cash (the Fed buys most bonds from them), these banks will be able to lend it out to businesses and consumers, thus generating economic growth. Second, by keeping fixed-income rates low, the Fed hopes to force investors and businesses to seek higher returns though riskier investing, whether through stocks or business expansion.
So what does this have to do with investing in gold?
Because the Fed is committed to its QE policy for at least another two years, and so is the European Central Bank and the Bank of Japan. With all of the world's primary central banks committed to the same strategy, it will be extremely difficult for one tide to turn the other. The enormous wave of Weimar Germany-style hyperinflation may not happen for a few years, if ever for that matter. And if inflation is low or non-existent (which is the case now), then why would investors need a hedge against it?
[See also: "Why Warren Buffett Hates Gold"]
What are you getting paid?
My biggest issue with gold as an investment is the income it generates, or lack thereof. Having $10,000 worth of Krugerrands just sits there like a shiny bump on a log. The value fluctuates minute by minute. You have rent a safe-deposit box to keep it in or, worse yet, if you bury it in the backyard, then you have to remember where it is. Oh, and it pays you precisely bubkus in dividends.
But having $10,000 invested in equities linked to hard assets such as energy master limited partnership (MLP) Buckeye Partners (NYSE: BPL) is different. The MLP will also fluctuate minute by minute with the gyrations of the stock market, as well as energy prices. You may have to pay a commission initially when you buy the shares. If it's allocated in an IRA account, then you may have to pay a small annual custodial fee. But you'll also receive an 8% yearly distribution for taking the risk of owning the shares.
With gold, you're paid nothing for the investment risk you are assuming. You can hope it retains its value and possibly appreciates. However, I don't consider hope a compensation plan. Neither should you.
Risks to Consider: Like every investor, I could be completely wrong. The wheels could fall off of the whole thing and we could be heating our homes with dollar-bills tomorrow. This is very unlikely to happen, but we never know.
Action to take --> Buying gold now is a sucker's bet. The chart alone shows that. The price of the GLD shows obvious signs of technical weakness, making lower highs and lower lows. If you've already made money in gold, then it may be wise to take some of it off of the table. It's OK to leave some on, especially if it's the house's money. But otherwise, gold's run is over.
If you're still worried about inflation, then owning equities linked to hard assets, as I mentioned earlier, makes sense. But make sure you're getting paid for the risk you're taking. Besides Buckeye Partners, real estate investment trust Senior Housing Properties (NYSE: SNH) is one of my favorite picks. Senior Housing pays you a 6% yield just for showing up. In addition, you can capitalize on real estate ownership and a bigger, macro-demographic trend that's happening in the United States.
And if you absolutely feel like your portfolio must have exposure to gold, then at least do it by owning gold-mining stocks. One of the biggest is Freeport McMoran Copper and Gold (NYSE: FCX). The stock pays a 3.5% dividend yield and has a forward price-to-earnings ratio of 8. That's pretty cheap based on the company's assets, plus you're getting paid 80% more than you would holding the less popular 10-Year Treasury note and 350% more than if you owned a handful of gold American Eagle coins.