With all the turmoil that’s been taking place in 2020, some investors are looking for the type of investments that do well in times of crisis. Gold may be the first asset class that comes to mind in that scenario. But should you invest in gold now? Keep reading to find out the reasons to buy — or not buy — gold, as well as how.
Should You Invest in Gold Right Now?
By itself, the steadily rising number of COVID-19 cases in the U.S. and worldwide could make a compelling case for investing in gold. But we’re also experiencing wide political divisions, international tensions, and rising government budget deficits. Not to mention a major monetary expansion by the Federal Reserve to deal with all of this.
Since gold is closely associated with crisis investing, it would seem like the right time to take the plunge. But if you’re thinking about it, you need to take a close look at the reasons to buy gold, as well as the reasons not to.
Different Ways of Owning Gold
We’re only going to do a quick run-through of the ways of owning gold since we cover the topic in detail in our article, “How to Invest in Gold.” You can refer to the article if you want a deeper explanation, but below is the summary version.
There are six basic ways to own gold:
- Gold ETFs and ETNs: These are funds that invest in gold bullion. You buy shares in a fund and own an equivalent amount of gold. Gold ETFs, which can be bought and sold through popular brokerage firms and traded like stocks, include SPDR Gold Shares (GLD) and iShares Gold Trust (IAU).
Gold ETNs, on the other hand, are instruments tied to the debt of gold-mining companies. You’ll be paid based on the performance of gold by the time the note matures. These are high-risk investments in which you can lose part or all your money. Gold ETFs and ETN can be bought through major stock brokers, such as E*TRADE, Public, or Ally Invest. Here’s a quick comparison between the three:
- Physical gold bullion: You can buy gold bullion coins in denominations of between 1/10 of an ounce to one full ounce per coin. These include American Eagle and Canadian Maple Leaf gold bullion coins, which can be purchased through online gold brokerages.
- Jewelry or collectible coins: These are probably the least efficient ways to own gold. Jewelry contains gold, but most of the price is typically in the piece’s fabrication, not the gold content. Collectible coins are commonly known as numismatic coins because their value is primarily based on the coin’s rarity and not the bullion content. These coins also have very high price markups on both purchase and sale.
- Gold mining stocks: Probably the most speculative play on gold since you’re investing in companies that mine gold, not in the metal itself. They have all the problems of other businesses and several that are specific to gold mining.
- Gold futures options: This is another high-risk play on gold because it involves leverage. Though you’ll have the potential to achieve very large gains, it’s also possible to lose your entire investment if the price of gold goes against you.
(Author’s financial disclosure: I have a position in the VanEck Vectors Gold Miners ETF (GDX) and own a small number of gold bullion coins.)
Reasons to Buy Gold
There are compelling reasons to buy gold, primarily as a long-term hedge.
1. Gold Preserves Wealth — Use It as an Inflation Hedge or Deflation Protection
According to the Bureau of Labor Statistics, inflation has caused prices to rise by 688% since 1970. Put another way, what would’ve cost you $100 to buy in 1970 costs $788 in 2020.
In 1970, the price of gold was about $35 per ounce. Its current value of $1,900 per ounce means that gold has risen by more than 5,300% at the same time. In that way, not only has gold kept up with inflation, but it’s easily outpaced it.
But how has gold performed during times of deflation? That’s a hard question to answer because deflation has been so rare in U.S. history. During the deflation-wracked decade of the 1930s — the decade was known as the Great Depression — the price of gold rose from $20 an ounce at the beginning of the decade to $35 by the end. That means gold experienced a 75% increase in value even when general price levels fell. That means the real return was something greater than 75%. (The increase was dictated by the U.S. government, which then kept the price locked at $35 until 1971.)
Gold, it seems, tends to react well during times of either inflation or deflation. It’s the times in between when it doesn’t seem to do as well.
2. Gold as a Safe Haven Against Geopolitical Uncertainty
Traditional assets, including stocks and bonds, thrive on stability. That includes economic, financial, political, and especially geopolitical stability. However, they tend to become more volatile during times of uncertainty, particularly when it’s geopolitical. That may be partly because geopolitical events take place outside the U.S. and beyond America’s immediate control.
By contrast, gold thrives during times of instability, particularly the geopolitical variety. It tends to rise during times when the threat of war or major commodity interruptions, particularly oil, rear their heads. And it’s worth noting that the price of gold has risen significantly since the start of the coronavirus pandemic. It increased by nearly 25% from $1,520 at the beginning of 2020 to the current level of nearly $1,900.
Even in 2020, we see gold continue to uphold its safe-haven status.
3. Gold as a Diversifying Investment
Gold may be the most alternative of all alternative investments. Though portfolio managers and investment advisers commonly recommend a mix of stocks and bonds, the reality is the two usually move in concert. That’s because the factors that drive one also propel the other.
For example, bond prices rise on declining interest rates. But since fixed-income investments compete with stocks, declining interest rates are also seen as bullish for stocks. And not only does it make stock returns more competitive with fixed-income investments, but lower interest rates also mean companies can borrow at a lower cost. The result is both stocks and bonds rising at the same time.
By contrast, when interest rates rise, it typically hurts both stocks and bonds.
Gold often — but not always — move independently of traditional investments like stocks and bonds. As discussed above, this is common during times of crisis, like geopolitical instability. While stocks and bonds may cause both declines in value on that instability, gold often thrives on it. A small position in gold can offset declines in traditional asset prices.
4. Gold Is a Counter Hold to the U.S. Dollar
It’s often thought that gold is a counter investment to stocks. That is, the price of gold goes up when stock prices go down. However, that connection is weak. There are times when both gold and stocks have declined in value simultaneously and when both have risen in tandem.
Closer to the truth is that the price of gold runs counter to the U.S. dollar. The dollar is the major international reserve currency, and when confidence in the U.S. and the dollar is high, the gold price tends to drop as investors move into dollars and sell gold.
But the opposite is also true. When confidence in the U.S. and the dollar declines, investors look for alternative currencies. Since few currencies are considered to be a true counterweight to the dollar, gold is often the default investor choice when the dollar weakens. After all, gold was money long before the first U.S. dollar was ever printed.
Reasons to Not Buy Gold Right Now
So does it make sense to buy gold now? Unfortunately, there are as many reasons not to buy gold as there are to buy.
1. Cash Is Safer and More Liquid
Even though gold has been money for thousands of years, government-issued currency — commonly referred to as cash — has been the primary medium of exchange for over 100 years. In most cases and in most transactions, it’s also the only medium of exchange.
When times get bad — which is usually the best time to own gold — there’s usually a correspondingly high demand for cash. After all, at a time when people may be losing their jobs or prices are rising, people still need cash to pay the bills. You can’t use gold to make your house payment, buy groceries, or fill up your gas tank.
This is a major reason there are times of crisis when all asset classes fall, including gold. Not that any of the reasons to own gold disappear, but rather the imperative to have cash for survival is greater.
Cash also has a major advantage over gold in that it doesn’t fluctuate in value. Yes, cash does lose value over time due to inflation. But in the short run — which is when cash is most important — it tends to hold its value at least in nominal terms. That can make it a safer short-term investment than gold.
There’s still another reason why cash may be the better choice, and it has to do with investing.
During times when the financial markets are in decline, it becomes important to accumulate cash. When the stock market begins to hit bottom, that’s the very best time to begin buying in. You’ll need cash to do that since you can’t buy stocks with gold.
2. Wide Price Swings
Historically the price of gold has been anything but stable. It has a long-term pattern of sharp upward price spikes, followed by gradual declines and multi-year stagnation. That casts doubt on its place as a long-term investment.
The screenshot below from MarketWatch shows the price swings in gold from April 2009 through September 2020.
Notice that the price started at below $900 an ounce in the spring of 2009, rose up to more than $1,800 per ounce in August 2011, then gradually stair-stepped its way down to the $1,100 level late in 2015. It briefly popped above the $2,000 mark this past summer before dropping down to the $1,900 level.
For all its virtues, gold has a long history of being incredibly volatile. And that’s the reason it should never occupy a large position in your portfolio.
3. Most Forms of Gold Ownership Do Not Pay Dividends or Interest
Except for certain gold-mining stocks that pay dividends, most gold ownership forms offer no steady income return. This is unlike dividend-paying stocks or fixed-income investments that pay interest.
Particularly in the case of dividend-paying stocks, you have an opportunity to earn a dividend yield while you’re holding the securities in the hope of selling at a higher price later. With most forms of gold, the sole financial benefit is in a price rise. There’s no income stream to tide you over until that happens. And if the hoped-for price increase doesn’t happen, the entire investment will be a guaranteed loser.
4. You’re Not Investing in Wealth Producing Assets
When you invest in a bond, the issuing company uses that money to grow its business. Or you invest in the stock of a company with a long history of providing valuable products and services. It offers employment for thousands of workers, steadily increasing revenues and profits and paying dividends to you as a stockholder.
None of that happens with gold because it’s essentially a static investment. When you buy gold, you take possession of the metal and hold it, at least in the case of bullion-related investments. And though there is the possibility of investing in wealth-producing assets through gold-mining stocks, that’s more the exception than the rule. Gold-mining stocks tend to be closely tied to the price of the metal. This makes them mostly a form of leveraging a gold investment. And even if a gold-mining stock is paying a dividend, it might be cut or eliminated when the price of gold falls.
The Bottom Line: Does It Make Sense to Buy Gold?
If you’re convinced now is the time to buy gold, proceed with caution. Because of its volatility and current high price level, you should limit your position to no more than 5% to 10% of your total portfolio. That will give you the portfolio protection you’ll need if circumstances get as bad as some believe they will while also limiting the potential losses when gold experiences one of its common price declines.
Written by Kevin Mercadante.
View the original article at here.