The case for buying gold, simply put...
"WATER IS BEST but, shining like fire blazing in the night, gold stands out supreme of lordly wealth," wrote
Pindar in his First Olympian Ode.
And ever since the Greek poet described gold in these glowing terms, back in 476 BCE, its identification with wealth has changed very little over the ages.
Indeed, priced as it is now in the ailing US Dollar – and compared with the struggling US economy's ongoing credit crunch – gold's association with wealth, whether secure or even "lordly", is particularly strong.
But three questions remain:
- Why should you buy gold?
- What place should it have in your portfolio?
- What should you buy?
"Why should I buy gold?"
Three of the most fundamental reasons for buying gold are the following:
- For economic security
- For physical security
- Against contingencies
Gold is an excellent long-term hedge against inflation. In the very long term, and despite sometimes quite significant short-term price fluctuations, gold has been shown to maintain its store of value in terms of real purchasing power. In other words, as the value – meaning the purchasing power – of the Dollar falls (and inflation goes up), so the Price of Gold rises.
Unlike all of the world's official government currencies, each of which represents debt incurred by the relevant issuing government, gold is not a liability. And since it is not a liability, it can neither be repudiated, nor its value undermined by inflation. This stands in stark contrast to the world's paper currencies that, printed as they are by 'fiat', always lose value in the long term. (This can, and does, also happen in the short term.)
In addition, gold has been shown not only to provide a strong hedge against a declining Dollar (Ed. Note: Gold is traded throughout the world, and it is always bought and sold in US Dollars; you can Buy Gold directly in non-US currencies thanks to BullionVault however), gold remains a better hedge against the Dollar than other commodities.
Gold is also a secure asset. In the past, when there was a gold standard, governments banned individuals from holding gold – preventing those individuals, in effect, from holding (and preserving) their wealth beyond the control of government.
As the young Alan Greenspan put it in 1966, long before he became chairman of the US central bank:
"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold."
Now, however, gold can be freely held. And as an asset, not only is gold liquid, but it is also subject neither to the freezes nor to the imposition of exchange controls that can, at times, threaten other asset classes and currencies. Once again, Mr. Greenspan explained in 1966 that "gold stands as a protector of property rights." It has a physical security not associated with any number of other assets.
Thirdly, gold is an excellent "crisis" hedge. Undisputed worldwide as a store of value, gold can be a form of "insurance" both in times of crisis and when there are extreme untoward movements in other asset classes. For example, during the period of hyperinflation in Germany from 1918-24, gold maintained its purchasing power while the value of bonds and stocks was catastrophically diminished.
Set apart as it is from other commodities because of its acceptability, portability, homogeneity and indestructibility, the market in gold is both universal and highly liquid. You can buy and sell gold around the globe. Even James Bond in From Russia with Love traveled with some 50 British gold sovereigns hidden in his briefcase – just in case!
"What place should gold have in my portfolio?"
A long-term asset portfolio needs to be diversified. This helps reduce both risk and volatility. The key to diversification is a choice of assets with returns as little correlated to each other as possible. Essentially, each of your asset classes needs to march to a different tune: Movement in one should be reflected as little as possible in the movement of any other.
Since there is, historically, little correlation between the returns on gold and on financial assets, such as equities, gold can help provide just such diversification. In other words, when financial markets fall, the price of gold tends to rise and vice versa. Or so says history, at least.
Recent research into the difference between gold and other assets has demonstrated that, in the long term, there is no important correlation between changes in inflation, interest rates and GDP and the returns on gold (such macroeconomic variables are strongly correlated with returns on such financial assets as bonds and equities).
The same research has also shown that changes in such macroeconomic variables have a much greater effect on the returns on other commodities (particularly non-ferrous metals and oil) than they do on gold.
Essentially, while the returns on typical financial assets are correlated to economic activity and cyclical demand, those on gold are not. A general market decline, therefore, will not be reflected in a general decline in the Price of Gold. Gold may, therefore, perhaps continues to provide protection against such declines.
In addition to reducing risk, improving a portfolio's diversification will also help to reduce its volatility. Reducing volatility will, in turn, often result in higher compound rates of return. And while it is more usual to look at different asset classes when building a portfolio, in the case of gold it is certainly worth considering it as an asset class in and of itself (rather than as an individual security within the commodities asset class) and, consequently, investing in it directly.
How much gold you should add to your portfolio, however, will depend upon the risk profile of your portfolio. If, on the one hand, you have a low-risk portfolio, the inclusion of gold can help enhance its performance. On the other hand, if you have a high-risk, high-return portfolio, with its strong lack of correlation to the equity and bond markets, the inclusion of gold could help bring stability in times of either economic turmoil or falling markets.
"What kind of gold should I buy?"
You can invest in physical gold in a number of ways and forms. Having decided to diversify your portfolio with physical gold, as opposed to investing, say, in gold-mining stocks, or a diversified gold-oriented exchange-traded-fund (ETF) or even gold futures, you have a number of choices.
Most obviously, you can invest in:
- Gold bullion (Ed. note: For best prices and live-market access, visit BullionVault)
- Gold coins – expect wide dealing spreads, plus the hassle of taking delivery
- Gold pools – be aware that the cheapest "pool" option, so-called unallocated gold, does not actually belong to you outright.
There are now exchange-traded funds that specialize in gold. Two big advantages are that they can provide investors both with liquidity and a cheap way of tracking the Gold Price. But as with gold pools, you do not physically hold gold. Nor do you have legal title or ownership. The only dealing fees with ETFs are your stock-brokerage fees, and annual expenses stand at 0.40% (Ed. Note: BullionVault bills 0.12% per year, starting from a minimum $4 per month, for outright ownership with full legal title).
Your choice will, once again, depend upon your risk profile. It will also depend upon how concerned you are with costs and the advantages of owning gold as your personal property.
Tax, too, will be an important consideration. For example, for tax purposes, not only are gold shares treated differently from the physical metal, but also, in some cases, different physical forms of the metal are treated differently from each other.
"When Should I Buy Gold?"
Since timing the market is impossible, and since most private Investment in Gold is for the long run, the important thing is that you buy it – if that's what you feel your portfolio warrants – rather than when you buy it.
Together with your investment manager or financial advisor, you should determine, based on accepted market theory just how much of your portfolio (typically 5-10%) needs to be put in to gold and in what form you are going to buy it.
Having made that determination, together, once again, with your investment manager or financial advisor, you should establish a program to invest in the metal using the principle of cost averaging. That is, investing a fixed amount in gold at regular intervals – whatever its market price may be.
Then, with gold in your portfolio for the long term, you will be investing not only in an established hedge against both inflation and the falling value of the US Dollar, but also in a liquid asset that constitutes a form of insurance against worst-case scenarios.
Most importantly, by adding gold to your portfolio, you will be helping to minimize your risks (through diversification) and potentially maximize your returns through reduced volatility.