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Beyond the Hype, the Real Reasons Some Investors Buy Gold

Why invest in gold? Yes, it gets hype. But there are real reasons smart investors buy gold.

Before you're tempting to invest in gold by all the hype, understand why people go for gold in the first place.Watch any financial news network for 30 minutes and you’ll likely hear someone talk about gold prices at some point. There’s a lot of volume in the precious metal trading hands on a daily basis and it’s easily one of the most popular asset classes out there. You’re probably wondering: “If all these people are talking about gold, should I be investing, too?”

There are plenty of ways to easily invest in gold. But before you pull the trigger, do you really know why you’re buying into gold, or are you just going along with the hype? Let’s consider a few things about investing in gold.

What’s gold worth? All depends on whom you ask.

You may have noticed that for all its popularity, gold is a highly volatile asset to invest in. Investors bearish on gold like to assert that the metal has no real intrinsic value, making it impossible to pinpoint a fair price target.

But that that logic is flawed.

Gold is used for a variety of purposes. As a great conductor of electricity, gold is used in almost every electronic device worldwide. Orbiting satellites use it as a radiation shield. The actual value of gold as an industrial metal may not equal its current trading price, but it’s hardly worthless.

How do pros use gold?

The most common use of gold in an investment portfolio is as an inflation hedge. Gold is negatively correlated with the value of the US Dollar, so as the dollar declines, gold rises. For this reason, goldbugs hail gold as the ultimate currency, one that will hold its value even as the cost of living rises faster than wages. The metal can be effectively used as an asset protector when inflation is high, but that doesn’t make it an investment for the long term.

The problem with using gold as an inflationary defense is that — in order for it to be the best investment during times of high inflation — the real rates of return from other investments must be negative. This happens when yields on interest rates like the 10-year treasury are lower than the rate of inflation. If inflation was rising at 3 percent, but the yield on the 10-year Treasury note was 3.5 percent, then the real rate of return would actually be 0.5 percent – not terrific, but not negative either. History gives us a great example of this: in the early 1980s, inflation was well above 10 percent, but interest rates rose above 20 percent, effectively putting a damper on the gold bull market.

ETFs only make gold more volatile 

Adding to the increasing volatility of gold is the advent of exchange-traded funds (ETFs). These investment vehicles have successfully securitized physical gold meaning that physical gold can actually trade at different price levels than the securities designed to mimic or invest in the hard asset.

Products like ETFs are great for traders, but don’t work so well if you want to hold gold as an inflationary measure. Shares of an ETF are not redeemable for physical gold and with little transparency; you never know exactly what’s held in these vehicles. It won’t help you hedge against stocks because ETFs trade as stocks. Furthermore, they are often subject to leverage, in some cases as high as 100 to 1.

If you want to hold gold in your portfolio, you may want to check what you own already. If you invest in mutual funds, the fund manager may already have a gold position established among the various assets he’s investing in. There’s nothing wrong with dedicating a small portion of your investment portfolio to gold, but it shouldn’t really be greater than 5 percent. Concentrate on building a portfolio made up of high-quality companies which have strong fundamentals rather than a precious metal that’s true value is dubious.

Published or updated on January 6, 2014

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About Daniel Cross

Daniel Cross has been in the industry as an investment writer and financial advisor since 2005. He holds the Chartered Financial Consultant designation (ChFC) as well as Series 7 and Series 66 licenses, and has embarked on the arduous journey of obtaining the coveted CFA designation. Daniel lives in Florida with his wife, daughter, and pet Tortoise ironically named Turbo.


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