Seven Reasons To Hate Gold As An Investment

Over the past few years, pretty much every investor has become familiar with gold. The shiny precious metal has surged in price and has managed to hold strong while broad indexes have slipped, highlighting its appeal as a diversification agent and safe haven investment. This has prompted many investors to ramp up their allocations to the space in order to take advantage of these favorable trends and lead their portfolios to broad gains. After all, gold-backed ETFs such as IAU have seen tremendous gains over the past few years including double digit returns in the year-to-date period and more than a 165% surge in the past five year period, figures that far outpace similar investments in the S&P 500 over the same time frame [see also Three Reasons Why Gold Is Overvalued].

Despite the many positives for gold, the metal has run into some significant headwinds as of late. The price of gold has slumped by about $300 from its recent highs and was trending around the $1,600/oz. level thanks to broad concerns over the global economy and a push back into dollars (though a rally in recent sessions has pushed the metal above $1,700). Since gold around the world is priced in U.S. dollars, an uptick in the value of the greenback tends to limit the demand for precious metals, making them less attractive in comparison, especially by those who view gold as an alternative currency [see Eight Legendary Gold Investors]. Thanks to this slumping price and the apparent topping out of gold in the short term, many are starting to reconsider the wisdom of investing in this precious metal. Fears over a bubble bursting in gold are starting to grow and a lack of demand from emerging markets, coupled with a stronger dollar, could force gold prices sharply lower to close out the year.

Yet, beyond these price concerns, there are a number of other issues that investors need to be aware of when considering allocating capital to the space, as there are several reasons to avoid the precious metal from an investment perspective. Below, we highlight seven reasons for why investors may want to temper their expectations for the metal and consider a more diversified approach that doesn’t include such a large allocation to the ‘barbaric relic’:

1. Gold Is Useless

The biggest knock against the yellow metal is its relative lack of uses in the industrial world. Close to two thirds of the current supply is used up in jewelry while investment accounts for another 20%. The remaining uses of gold go to dentistry, electronics, and a smattering of other applications that make up less than 5% of total demand. This is in sharp contrast to pretty much every other product in the commodity world. While copper and soft commodities are almost exclusively used for industrial purposes, the rest of the precious metal group sees a great deal of their production scooped up by industrial uses as well. Silver, platinum, and palladium, all find their way into several key applications including catalytic converters and electronics, not to mention more ‘new age’ technologies such as alternative energy. Although this may not necessarily be a bad thing given that it ensures that gold is entirely tied to ‘fear’ and dollar confidence, it does suggest that when industrial demand is surging, gold could be left out in favor of its more ‘useful’ cousins [read Gold ETFs Shine, Silver ETFs Shine Brighter].

2. High Premiums For Physical Exposure

While bid/ask spreads are generally pretty tight for gold futures, stocks, and ETFs, investors are likely to encounter a different trend in the physical gold space. Premiums on one ounce gold coins can be as much as $90 over spot price, a level that, at current prices, represents a nearly five percent cost to investors. While premiums go down when investors buy larger quantities, they are still a significant cost, with 10 oz. bars currently possessing a roughly 2.7% premium per ounce. One has to expect a similar, if not greater, situation to arise when selling a bar of gold suggesting that one has to obtain a nearly 10% gain just to break-even on a gold investment. Add in extra costs to ship the products, develop secure storage locations or to get a safe deposit box at a bank, and investors who seek to purchase gold and sell it within a short period of time seem almost destined to lose money.

3. Inflation Is Low

Inflation, as represented by CPI, has been extraordinarily low for quite some time now in this country. In fact, inflation has only topped 5% once in the past 25 years while double digit inflation has not been in the marketplace since 1980. Furthermore, rates on bonds are also plumbing fresh lows on a seemingly monthly basis, suggesting to many that inflationary risks are still pretty slim, at least for the time being. This trend is further confirmed by a number of aspects in the American economy which appear to be deflating rather than inflating. For example, home prices are still flat and are no longer in ‘bubble territory’; instead it is quite the opposite as many analysts are calling for further losses in the housing sector.

A similar situation is happening in the consumer credit arena as well, as many citizens look to deleverage their balance sheets and clamp down on spending. As a result, many economists are worried about deflation and not inflation, much like Japan after its credit bubble popped in the late 80′s. Granted, this low inflation rate might change in the near future given the rapid increases in money supply and the possible loss of faith in the dollar, but at least for the time being, a slow steady rate of price increases looks to be here to stay, limiting gold’s appeal in this environment [see Detailing Gold's Wild Q3].

4. Still Ends Up Being Tied To Fiat

One of the top reasons for gold bugs’ love of the metal is that the product isn’t subject to the whims of central banks around the world. Gold cannot be printed while dollars can be in an apparently unlimited supply driving down the value of dollars relative to gold. This is a great point for the most part as the Federal Reserve has done a terrible job of managing the money supply and the value of the dollar over its history, leading further credence to this idea. However, the main problem is that gold often ends up being tied to fiat decisions no matter what. For much of American history, the price of gold has enjoyed a fixed relationship to dollars. This rate was set by the government and has been adjusted several times in order to respond to market forces and crises such as the Civil War in which the dollar could not– at least for a short time– be converted into gold. Fast forward to the Depression and a similar situation arose when FDR confiscated all of the gold in the country and immediately devalued it by close to 60%.

The point is, even at times when gold was the money of the land, governments had a substantial influence over its price either revaluing it outright or decreasing the metalic content of coins by fiat. Furthermore, gold only really has value because people believe it does. How this is any different than fiat currencies seems questionable at best and remains a very real problem for those who are advocating its return as a monetary instrument. While gold would arguably be a better monetary base given the current situation and the never-ending dollar printing, to think that it will not be influenced by fiat decisions seems pretty unlikely to say the least [see Three Ways To Play $2,000 Gold].

5. Terrible Long Term Performance

Over the past few years, gold has been an all-star of the investing world, putting up gains that few investments could match. For example, over the past decade, gold has risen from about $250/oz. to its current level above $1,600/oz. an impressive gain at a time when broad markets were flat. While this is a pretty good track record, over longer time periods the metal hasn’t done so well, failing to produce similar returns for investors. In fact, during the decade from 1991-2001, gold prices were pretty much flat while the S&P 500 nearly quadrupled. Furthermore, for any investors unfortunate enough to buy into gold at the end of 1979, right before the metal’s all time peak, another flat performance was pretty much guaranteed over the 80′s, if not significant losses. Meanwhile, the S&P 500 nearly tripled in the same time frame, once again crushing gold’s performance. While some might argue that these are ‘cherry picked’ results– and to an extent they are– it is difficult to find a decade that gold outperformed the S&P 500 besides the most recent one, suggesting that unless recent trends continue, investors with huge positions in gold may be very disappointed [read Three Reasons Why Gold Is Overvalued].

6. Hard To Value

Gold, like many commodities, is notoriously difficult to value. The product has no cash flows, dividends, or earnings, so values must be calculated based off of market sentiment and supply/demand imbalances and nothing more. While this may be fine in markets such as cocoa or wheat, gold, thanks to its historic role as money and its lack of industrial uses, can have sort of an odd relationship with markets due to this reality. Gold will often trade off of fear levels which is obviously hard to judge and can swing wildly in a short matter of time. Thanks to this, gold’s price is pretty much determined by investor sentiment, making valuation models useless for this asset class. “Gold is going up because people are buying it, and people are buying it because it’s going up,” said Leonard Kaplan, president of Prospector Asset Management in Evanston, Ill., and a longtime gold trader, highlighting just how tough it can be to figure out why gold goes up or down in a given trading period [read Are Gold Miners A Buy?].

7. Euro Turmoil

One geopolitical situation that looks to be impacting gold over the next few months is certainly the crisis in Europe. The continent has failed to get its debt situation under control and an expanded European Financial Stability Facility seems to be a necessity in order to boost confidence in the struggling bloc. Even then, an expanded program could sink the French economy and push investors to consider the trillion dollar market as only slightly better than the PIIGS nations. If this happens, it could still make investors reconsider a huge allocation to euros and bring up a fresh crop of issues in its stead. After all, what is bad for Europe has proven to be great news for the dollar over the past few months as the greenback has gained against its main currency counterpart in the past few weeks.

Given this, many should not be surprised to note that gold has had a very rough stretch as the metal tends to move inversely compared to the U.S. dollar’s value on the world stage. Assuming that these trends continue into the near future, and thanks to continued uncertainty in nations such as Spain and Italy, not to mention growing worries over France, they probably could. This would force many investors to buy up dollars as protection, pushing gold investments sharply lower in the process once again [see The Complete Guide To Investing In Gold].

Moral Of The Story

Gold bugs are likely to be experiencing a mild heart attack by this point in the article but the above reasoning is hard to deny for most investors. With that being said, it doesn’t necessarily make gold a bad investment overall– especially in the short-term– just that investors need to consider these issues before plunking down a huge chunk of their portfolio’s dollars into the precious metal. While gold seems poised to keep its current price thanks to continued expansion of the monetary base around the world, it is always important to keep things in perspective.

Gold is not the be all end all of precious metals investing and many should likely consider diversifying across the space in order to protect against any market movements. After all, the rest of the precious metal group still has the same currency appeal as gold but can offer different risk/return profiles that could make them excellent choices for investors seeking more diversification in the space. Personally, I am long gold in both ETF and physical form, however, this represents a small portion of my portfolio that is used to hedge against a total collapse in the broad economy. In other words, a small allocation to the metal seems warranted given the broad concerns in the global marketplace and as an insurance policy against a collapse. With that being said, an allocation to gold exceeding even 10% of a portfolio seems like a terrible idea given the reasons outlined above, especially over the long-term, as history certainly isn’t on the shiny metal’s side [read The Ultimate Guide To Gold Investing].

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Disclosure: Long IAU, gold bullion.

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Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

25 Responses to “Seven Reasons To Hate Gold As An Investment”

  1. [...] Eric Dutram: Over the past few years, pretty much every investor has become familiar with gold. The shiny precious metal has surged in price and has managed to hold strong while broad indexes have slipped, highlighting its appeal as a diversification agent and safe haven investment. This has prompted many investors to ramp up their allocations to the space in order to take advantage of these favorable trends and lead their portfolios to broad gains. After all, gold-backed ETFs such as the SPDR Gold Trust (NYSE:GLD) and iShares Gold Trust (NYSE:IAU) have seen tremendous gains over the past few years including double digit returns in the year-to-date period and more than a 165% surge in the past five year period, figures that far outpace similar investments in the SP 500 over the same time frame [see also Three Reasons Why Gold Is Overvalued]. [...]

  2. [...] Just a few short years after the introduction of the first exchange-traded commodity product, there are dozens of options available for investors interested in accessing this asset class that is capable of delivering big returns and meaningful diversification benefits. Most investors are familiar with only the largest and most popular of these products, but those willing to dig a bit deeper will uncover some very intriguing investment opportunities [see also Seven Reasons To Hate Gold As An Investment]. [...]

  3. [...] Just a few short years after the introduction of the first exchange-traded commodity product, there are dozens of options available for investors interested in accessing this asset class that is capable of delivering big returns and meaningful diversification benefits. Most investors are familiar with only the largest and most popular of these products, but those willing to dig a bit deeper will uncover some very intriguing investment opportunities [see also Seven Reasons To Hate Gold As An Investment]. [...]

  4. [...] One of the biggest ETF winners on the day came from the Market Vectors TR Gold Miners (GDX) which saw gains of 2.5% on gold’s strength. In a rather curious fashion, gold has been stuck in something of a correlation rut the past few sessions, as it moves parallel to major indexes. This pattern slaughtered the metal the past two days but worked to gold’s advantage for Wednesday’s session. GDX, a popular mining fund, represents something of a leveraged play on the precious metal as mining firms tend to have high beta scores. This explains why GDX outperformed GLD and gold itself on the day [see also Seven Reasons To Hate Gold As An Investment]. [...]

  5. [...] One of a biggest ETF winners on a day came from the Market Vectors TR Gold Miners (GDX) that saw gains of 2.5% on gold’s strength. In a rather extraordinary fashion, bullion has been stranded in something of a association rut a past few sessions, as it moves together to vital indexes. This settlement slaughtered a steel a past dual days yet worked to gold’s advantage for Wednesday’s session. GDX, a renouned mining fund, represents something of a leveraged play on a changed steel as mining firms tend to have high beta scores. This explains because GDX outperformed GLD and bullion itself on a day [see also Seven Reasons To Hate Gold As An Investment]. [...]

  6. [...] While keeping an uncorrelated portfolio is certainly important, correlation should always be taken with a grain of salt. Anyone familiar with these precious metals over the past few years is fully aware that they have been steadily outpacing the S&P 500. But how can two assets with high correlation have such different returns? The difference comes from the downside risks that each feature. Simply put, precious metals have a much lower downside risk than equities, allowing them to hold their ground. For example, if SPY drops 5% in a day and GLD drops 1%, the correlation between the two assets would still be relatively high, but the returns turn out vastly different [see also Seven Reasons To Hate Gold As An Investment]. [...]

  7. [...] While keeping an uncorrelated portfolio is certainly important, correlation should always be taken with a grain of salt. Anyone familiar with these precious metals over the past few years is fully aware that they have been steadily outpacing the SP 500. But how can two assets with high correlation have such different returns? The difference comes from the downside risks that each feature. Simply put, precious metals have a much lower downside risk than equities, allowing them to hold their ground. For example, if SPY drops 5% in a day and GLD drops 1%, the correlation between the two assets would still be relatively high, but the returns turn out vastly different [see also Seven Reasons To Hate Gold As An Investment]. [...]

  8. [...] Gold is still sitting well below its highs of last year, leading many to believe that it is only a matter of time before we see the metal shoot back up in price. With the commodity appearing to be relatively cheap, many have argued that now is a great time to buy in while others urge that gold has yet to hit its bottom. Though 2012 has been short thus far, gold has been making significant strides and is already flashing signs of a similar performance to the first half of last year. For those looking to make a play on the elusive commodity, the iShares Gold Trust (IAU) is one of the the best options. This physically-backed ETF offers fees of just 25 basis points and is one of the most popular funds on the market. For those a bit more savy to commodity investing, buying a longer-term GC Gold futures contract on the COMEX may be your best bet [see also Seven Reasons To Hate Gold As An Investment]. [...]

  9. [...] With no major economic data releases on the home front this week, investors will likely turn their attention back to developments in the debt burdened currency bloc. Gold prices have been quietly inching higher alongside equity markets these past few weeks, however, with the Euro zone back in focus, the precious metal may soon face unexpected headwinds [see Seven Reasons To Hate Gold As An Investment]. [...]

  10. [...] With no major economic data releases on the home front this week, investors will likely turn their attention back to developments in the debt burdened currency bloc. Gold prices have been quietly inching higher alongside equity markets these past few weeks, however, with the Euro zone back in focus, the precious metal may soon face unexpected headwinds [see Seven Reasons To Hate Gold As An Investment]. [...]

  11. [...] gold futures climbed higher throughout the trading day, settling near the $1,750 level [see also Seven Reasons To Hate Gold As An Investment]. GLD climbed higher as Greek officials have yet to agree to the EU and IMF’s demands which [...]

  12. [...] morning, bullion futures climbed aloft via a trade day, settling nearby a $1,750 turn [see also Seven Reasons To Hate Gold As An Investment]. GLD climbed aloft as Greek officials have nonetheless to determine to a EU and IMF's final [...]

  13. [...] gold futures climbed higher throughout the trading day, settling near the $1,750 level [see also Seven Reasons To Hate Gold As An Investment]. GLD climbed higher as Greek officials have yet to agree to the EU and IMF’s demands which [...]

  14. [...] As far as commodities are concerned, not even gold’s safe haven qualities could keep it afloat today, as the precious metal promptly lost $18.4/oz. while crude oil dipped by $0.84. Commodities had been enjoying a rather strong year, but volatility struck the markets this week, preying on assets that are already known for their rapid daily movements. News also broke today that the S&P downgraded not one, not two, but 34 Italian banks, sending fear pulsating through the global economy. In an effort to keep our readers better educated on the happenings of today’s fast paced financial world, we outline two of the biggest ETF movers on the day [see also Seven Reasons To Hate Gold As An Investment]. [...]

  15. [...] Buffet goes onto propose a compelling example which illustrates his criticism of the shiny metal. He offers investors a hypothetical choice between two piles; the first pile is all of the gold in the world, about 170,000 metric tons, worth an estimated value of $9.6 trillion. The second pile is worth an equal amount, which could buy approximately 400 million acres of U.S. cropland, 16 Exxon Mobils, and still have about $1 trillion left over [see Seven Reasons To Hate Gold As An Investment]. [...]

  16. Charles Thompson says:

    “. . . this represents a small portion of my portfolio that is used to hedge against a total collapse in the broad economy. . . .”  That sounds fine if you have a very large portfolio, but for a modest portfolio, 10% insurance won’t help much in case of a “total collapse”.  Just as when insuring your life (for the benefit of our family) or your home, you buy as much insurance as you need (or can afford).  For most folks, 10% won’t do it.

  17. [...] Apple (AAPL) has been one of the best performing stocks of the last several years, and has also become one of the most widely followed companies ever. The stock has been climbing sharply higher, recently piercing through the $600 level–a feat that just a few years ago would have seemed impossible. Given the red hot performance, most professional money managers feel as if they have to own AAPL stock–despite some concerns about the current valuation and a potential pullback in share value. Despite the company’s impressive resurrection and status as a leading tech innovator, there are reasons to be a bit nervous about the stock as currently priced [see Seven Reasons To Hate Gold As An Investment].  [...]

  18. [...] The last of the doomsayers, Robert Prechter, is by far the most bearish one from the bunch. Pretcher feels that both investors and consumer are tapped out, deeming the run-up seen on Wall Street as a classic bear market rally. He recommends that investors avoid all major asset classes, including stocks, bonds, commodities, and even precious metals [see also Seven Reasons To Hate Gold As An Investment]. [...]

  19. [...] With equity markets charging (generally) higher since the start of 2012, it’s no wonder that gold has been largely off the radar for many investors. Despite evading news headlines over the past few months, speculation over where the precious yellow metal is headed has not died down one bit. Given the impressive bull-run on Wall Street coupled with looming worries surrounding the health of the economic recovery, the fundamental price drivers of gold may be sending conflicting signals of where the metal is likely headed in the foreseeable future [see also Seven Reasons To Hate Gold As An Investment]. [...]

  20. [...] This ETF has bounced back successfully from the $136 level, although it may still encounter resistance as it nears $142 a share, seeing as how it has yet to close above this price level [see also Seven Reasons To Hate Gold As An Investment]. [...]

  21. [...] Also consider that IAU’s cheaper fees will mean that it will generally outperform its competitor. Though the difference will be slight, there will be a noticeable delta between the two when the time frame is expanded to multiple decades. Note that GLD’s size and trading volume can tweak these numbers a bit, but evidence shows that assets may be headed towards IAU, which could erase this issue in time. IAU slashed its expense ratio in mid 2010, making 2011 its first full trading year at 0.25%. Last year, IAU saw cash inflows of over $2.7 billion, while GLD saw outflows of $372 million, suggesting that long term investors have begun to catch on to the money saving trend between these two ETFs [see also Seven Reasons To Hate Gold As An Investment]. [...]

  22. [...] Gold is without a doubt one of the most favorite assets among active traders as it holds appeal as both a safe haven and hedge against inflation while also serving as an indicator of fear and uncertainty in the global market. GLD is the most popular physically-backed gold ETF on the market, offering tremendous liquidity and an active options market for more sophisticated traders [see Seven Reasons To Hate Gold As An Investment]. [...]

  23. [...] Nothing shines like gold. This physically-backed ETF offers exposure to the spot price of gold bullion, which has been one of the best performing asset classes over the past decade period. Gold prices have experienced astronomical gains over the past five years as the recent financial crisis sparked a widespread flight to safety. The precious yellow metal has rightfully earned its reputation as a safe haven, capable of holding its ground and even appreciating in times of uncertainty. IAU has amassed just over $9 billion in assets under management since launching in the beginning of 2005 [see also 7 Reasons To Hate Gold As An Investment]. [...]

  24. GREG MORRISON says:

    This might be helpful to those might interested to buy or invest gold like me.

  25. Caroline says:

    I have to disagree that gold is useless. As a woman interested in investing, the idea of investing in gold is especially appealing. Despite not having many ‘practical’ uses, gold is crucial to the fine jewelry industry and despite the state of the current market, there will always be consumer demand for the precious metal.

    http://www.wyattresearch.com/

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