Gold is a Lousy Investment

Yes, you read me correctly. Gold, despite recently surging to new all-time highs, is a truly lousy investment. And this is not just my view; it is the view of Benjamin Graham, the mentor of Warren Buffett and the father of modern investing! Consider what Graham had to say about the barbarous relic in his classic The Intelligent Investor:

The standard policy of people all over the world who mistrust their currency has been to buy and hold gold. This has been against the law for American citizens since 1935—luckily for them. In the past 35 years the price of gold in the open market has advanced from $35 per ounce to $48 in early 1972—a rise of only 35%. But during all this time the holder of gold has received no income return on his capital, and instead has incurred some annual expense for storage. Obviously, he would have done much better with his money at interest in a savings bank, in spite of the rise in the general price level. The near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast grave doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in “things.”

Graham wrote these words just before the massive 1970s bull market in gold and other commodities, making his timing extraordinarily bad. But his logic is still sound. What kind of investment pays no income...yet COSTS money to store?

And contrary to the claims of the gold bugs -- which tend to be based more on political ideology than actual economics -- gold is nearly as susceptible to "printing" as paper currencies. The amount of gold in circulation as coins and bullion is by no means fixed. (Just ask the Hunt brothers what happens when you assume the supply of a precious metal is fixed and you attempt to corner the market...). New supplies of gold are mined every year, and long-forgotten pieces of jewelry suddenly reappear and find themselves at the local pawn shop when prices get high enough. (The supply of gold is obviously less expandable than that of paper currencies, but you get my point).

It should also be mentioned again that it was the hated US dollar -- not gold -- that investors ran to during the 2008 meltdown.

Gold, over the long term, is a terrible investment. But -- and it may surprise you to hear me say this -- I'm not necessarily recommending that investors dump their holdings immediately. A lot of really BAD investments can make really good trades. The "dot com"stocks of the late 1990s were investments of such laughably poor merit that you cannot believe today that anyone was stupid enough to buy them. But as bad as they were, a lot of traders made a pile of money riding them up to the peak of the Nasdaq bubble -- if they were smart enough to sell near the top.

Gold may have already peaked, or it may well have another 50% surge left in it. I have no idea and will not hazard to guess. It's impossible to say what gold is "worth" because it has no intrinsic value. And you never know how irrationally high a bubble will take a given asset.

My advice is this: view gold for what it is. It's not an investment. It's a highly-speculative trade. Approach it as a trade, use stop losses, and don't be afraid to take a profit (or loss, for that matter). But most of all, don't believe the hype. The arguments for gold today are the same ones used in the 1970s (often made by the same people, who never seem to go away). They were wrong then (as the 1980s and 1990s proved) and they are wrong today.

The article was originally posted in the HS Dent Blog.

After my original post was published in the HS Dent Blog, I saw a good article in the Wall Street Journal by Mark Gongloff:  "Golden Era for Gold?  Maybe, Even at $1,141.40."

Gongloff writes,

Up 62% since last November, gold is enjoying a moment that is either the start of an amazing bull run or one of those magazine-cover episodes that precedes a fall....  Gold looks increasingly bubbly, but bubbles often inflate more than we can imagine.

My thoughts exactly.  Gold is showing the classic signs of an asset bubble, and opinion is almost unanimously bullish on the yellow metal.  Even central banks, who tend to be the worst market timers in the world, are piling in, as are retail investors across the globe. This would appear to be a contrarian signal to bet the other way.  But, as Gongloff says, bubbles can often inflate for far longer that anyone believes possible.  My advice, again, is not to sell gold.  By all means, take advantage of this speculative mania to make some quick money if you have the stomach for the risk.  But keep your perspective -- this is a short-term, highly-speculative trade, not an investment.

Charles Lewis Sizemore, CFA
www.charlessizemore.com

Check out Charles's new book, available on Amazon.com: Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

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