Is Gold an Investment or a Hedge?

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“Gold to hit $2,500 per ounce!” “Buy gold now and score big!” “Gold will go to $8,000 per ounce!” If you have seen headlines like these recently, you aren’t alone. It seems that the hype is everywhere. And with the economy in the condition it’s in, many people are not only looking to make more money; they are also seeking to protect what they have left. With all of that in mind, it is very important to understand how and where gold can fit into your strategy.

First to be addressed is the question of gold as an investment or a hedge. What’s the difference? Basically, an investment is something that is expected to increase in value, through some type of growth. Planting a kernel of corn and expecting to receive several ears of corn full of kernels might be a good analogy. A hedge, on the other hand, is something that is expected to protect from a loss of value. A hedge around your field to keep out thieves or destructive animals might be a good way to think of it. You don’t expect to reap any increase in benefit; you simply want to protect what you already have. As another example, a farmer might plant a hedge around his field of corn to protect his investment against destructive forces.

Traditionally, gold has been seen as a hedge; a hedge against inflation or the falling value of a dollar. Actually, the price of gold is strongly tied to the dollar. As the value of a dollar falls, the value of gold rises. As the dollar strengthens, the appeal of gold weakens. If you read the news about the value of gold, headlines such as, “Gold Falls on Reports of the Strengthening Dollar” or “Gold Rises as the Dollar Weakens” are commonplace.

As just one example, the average cost of rent in 1979 was $280.00 per month. In 2009, it was $800 per month. Although the number of dollars received per ounce of gold is higher, it doesn’t really buy very much more than it did. Another way to look at this is that the cumulative average for an ounce of gold in 1979 was $307, as of October 2009 it was $946. According to the US Department of Labor’s Consumer Price Index Calculator, $307 in 1979 dollars is worth $913 today (again, as of October 2009). So, in 30 years, someone who bought an ounce of gold is only $30 ahead. Not a stellar performance. However, if that same person had tucked $307 dollars in their mattress in 1979, today it would only buy one-third of what it did back then. This is how gold acts as a hedge against inflation and the falling value of a dollar.

So, is gold an investment? For it to be an investment, you would need to see some sort of growth, which the above example shows hasn’t happened. Obviously, a pile of gold isn’t going to increase in size just sitting there, so what other ways to increase value might there be? One thing that increases value is scarcity (think diamonds), but they still mine gold. Another way would be increased demand (real demand, not manufactured hype), but there seems to be enough gold in the pipeline for industrial and other uses. A bad economy would actually reduce demand for one of the chief uses of gold – fine jewelry. So that doesn’t seem to be the case right now, either.

That doesn’t mean that there isn’t money to be made buying and selling gold, but that is purely on the basis of speculation. For example, on January 2, 1979, the price for an ounce of gold was $218.60. On January 21, 1980 the price topped out at $850.00 per ounce. That is a 389% increase in little over a year! However, by the next day it had dropped to $737.50, or a 13% drop in 24 hours, and by March 18, 1980 it was back down to $481.50. That’s a 43% drop in two months from its high point. In the following years, it fluctuated up and down, until the recent increases. So, just like the stock market, timing is everything.

If someone would have bought $1000 worth of gold on January 2, 1979 and sold it on January 21, 1980, they would have made out well – a profit of $2,888.38! However, if that same person had bought gold at the peak of the frenzy, by the next day they would have lost $112.50 per ounce. By March, they would have lost $368.50 per ounce – almost half of their money! For a person that bought $1000 worth of gold on January 21, 1980 and sold it on March 18, 1980, they would have lost $433.53!

Another statistic: A person who bought gold at the high point in 1980 and sold at the high point in early December 2009 would have seen an increase of their “investment” of 44%. During the same time period, an interest bearing checking account would have gained 92% – more than double! Nobody would refer to a checking account as an investment, so we need to really think about all of the talk about gold as an investment.

Bottom line: If you are looking for a hedge against inflation, gold might be part of your portfolio. If you are looking for an investment, it would be best to look elsewhere. But if you just want to play the market and enjoy the wild ride gold is on – knock yourself out!

Disclaimer: In the interest of full disclosure, it should be stated that the author is the owner of South Kansas City Gold Buyer, a local scrap gold buyer based in Kansas City. For more information about this business you can visit sokcgoldbuyer.com.

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