Readers of the Investment Watchdog Newsletter often ask about investing in gold. They have seen or heard advertisements trying to sell gold. Salesmen quote figures that show that the price of gold has risen and will continue to rise. They also say that gold is a hedge against inflation. Let's examine those claims by looking at the chart below on the price of gold per ounce for the last year.
Has the price of gold risen? Yes, if November of 2008 is compared to the present price. There are several starting points on the graph that are lower than the present price of about $930 per ounce. But there are also several starting points on the graph that are higher than the present selling price, too. Investors buying in mid July 2008, April 2009, March 2009 and June 2009 would lose money if they sold at today's price. Investors buying the first week of July 2008 and selling exactly one year later in 2009 would get the same price they paid less their investment expenses. Just like every other investment, the price of gold varies, has risks and is nearly impossible to predict, no matter what salesmen claim.
Is gold a hedge against inflation? Again, look at the chart above. For the last year, the price of gold has been up, the price of gold has been down and the price of gold has been unchanged. It all depends on which starting point is compared to today's price. Inflation has been very low for the last year due to the recession. Consumers who don't have jobs or fear losing their jobs don't spend and push up the price of goods and services. And the present recession is expected to last many more months, which means inflation should stay low until the economy recovers. So if gold is a good investment in times of high inflation, is it a bad investment in times of low inflation? Not according to the chart. The price of gold is up and down while inflation has remained very low. So the price of gold and inflation are not directly related. It is true that the price of gold has gone up during periods of extreme or hyperinflation because investors buy gold for safety when there is a national or global crisis like war or government losing power, but inflation is definitely not the only reason that the price of gold changes.
Gold is a commodity, meaning that is has commercial uses. Therefore supply and demand affect the price of gold. Gold is consumed when jewelry is made, sometimes in denistry and also has commercial uses in industry as an excellent conductor in the electronics industry. All uses of gold combined constitute a total demand. The supply of gold is determined by gold mining. Both supply and demand of gold can vary greatly depending on market conditions, affecting the price of gold. So the price of gold is not determined solely by inflation. Just like everything else, the price of gold is determined by supply and demand.
There are several ways to invest in gold. Probably the most expensive way is to buy physical gold. Raw gold has to be assayed to determine its purity. It has to be shipped. It has to be stored. It has to be insured. It has commissions due to the salesman. All these expenses add a high percentage of the price of gold and either reduce profits or add to losses for the investor. Another way to invest in gold is to buy foreign coins made of pure gold. Some of these coins sell for very near the value of the gold contained in them, but some of them have a high markup compared to the price of gold contained in each coin. Another way to invest in gold is to buy gold mining stocks. Usually the price of gold mining companies goes up or down in sync with the price of gold. There are also gold mutual funds and gold exchange traded funds available for investors.
So gold is available readily in many forms. But it is not guaranteed to increase in value and it is not solely a hedge against inflation as salesmen would have novice investors believe. Remember the old joke about "Figures don't lie, but liars figure?" Apply that wisdom if you are considering buying gold. Gold is a volatile, speculative way to invest. If you decide to buy gold, be sure to compare investment expenses and diversify into other classes of assets, like stocks, bonds or real estate. Consider limiting gold to no more than 4% of your net worth just as you would any other individual stock. Don't become a victim of sales pitch with your life savings.
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