What About All Those Ads Telling Me to Buy Gold?

From the beginning of time, gold has been a valuable commodity and probably always will be. It can be a good hedge against inflation and I wouldn’t be against having up to 5% of my portfolio in gold for that reason. But historically it is one of the worst performing assets. This is because gold pays no interest, no dividends (and therefore cannot provide the all-important compounding of reinvested interest and dividends) and creates no business value.

The only way to profit from gold is to time the market. In other words, you are relying on the greater fool theory. Yes, you may be a fool for buying at $1,000 an ounce but if there is an even bigger fool who will take it off your hands at $1500, you still make money. But how many fools are out there? (Actually, quite a few, but I digress.) How high can the market go? The trick here is to avoid being the greatest fool of all, the one who buys at the very top of the market.

Gold has been rising over the past few years because gold is viewed as a safe haven and there have been fears of everything from economic collapse to hyperinflation (more buyers than sellers drives up the price). When prices keep going up and up and up, we call this a bubble. If you recall, we had one of these recently in real estate (and stocks in the late 90s). Bubbles are not anything new. We seem to have a bubble of some kind about once every decade. Ever since the tulip bulb crisis in the late 1500s (probably the earliest bubble on record), there have been booms and busts in just about everything.

While millions have been made from trading commodities and collectibles, the financial law of gravity always seems to prevail -- eventually. The key is to know when eventually is going to take place. This is no small task!

Just keep in mind that when dealing with precious metals and other commodities and collectibles, you have left the realm of investing and entered the world of speculation. As long as you understand the risks and do not spend more than you can afford to lose, hey, you never know, you may hit a home run. But if you strike out, well, maybe you had some fun, but more importantly, you still have your nest egg.

MM

Addendum: See this excellent New York Times article: http://www.nytimes.com/2013/07/28/business/budging-just-a-little-on-investing-in-gold.html?smid=pl-share&_r=0