Wednesday, February 3, 2010

Should you invest in GOLD? Uh, No.

Should you invest in GOLD? Uh, No.

As the chart above illustrates, gold prices have gone up over the last few years. Many websites, television shows, newspaper advertisements, and the like are hyping Gold as a good investment for the average consumer.

Should you invest in Gold? The answer is NO and let me tell you why.

In shaky financial times, like we have today, where people are worried about finances, many turn to gold as an investment vehicle, thinking that the "security" of a mineral is better than some currency or stock investment. As a result, the price of gold skyrockets during such times.

When times get better, gold prices either drop or flatten out. Here is another chart that might give you a better idea of the historical price of gold and where it may be going:

As you can see from this second chart, the price of gold spiked in the past, in fact is spiked right at the peak of our last financial crises in 1979. Then, it dropped and stayed relatively flat for over two decades - until about 2007. If you had "invested" in gold in 1979 at the peak of the market, you would only have made back your investment in 2007 - and even then, taking into account inflation and the opportunity cost of money, you would still be behind.

2009 has been a scary year for many people, and gold is spiking again. People hawking gold on television (including the odious Glenn Beck) show you the first chart above and say "Look at how gold is going up, up, up!" and entice you, the unsophisticated investor, to buy.

Gold is a commodity, and commodities are a risky investment for any investor, particularly one that is not familiar with the commodity. You can lose your shirt in commodities if you don't know what you are doing. The idea that you should buy any investment because it has "gone up" is flawed. Usually if an investment increases dramatically in value, that means it is too late to jump on the bandwagon. The investment may go up some more, but most of the desirable gain has already occurred. When it starts to tank, the people who bought last, or close to last, get stung the hardest.

So yes, if we had a crystal ball, buying gold in 2005 would have been a good investment. And selling it in 2010 would be a smart move - unload your gold onto the people dumb enough to follow Glenn Beck's financial advice. There will likely be another drop in the price of gold, just as we saw in 1982.

Why is this? Again, gold is a commodity. They dig it out of the ground. You can even refine it from seawater. The cost of making gold and the price of gold are two different things. Once the price of gold reaches a certain point, gold mining operations ramp up to cash in on the market. Mines that were once not profitable are re-opened to go after more gold. People who were sitting on gold mines will decide to go after the ore and refine it and sell it.

It's call the theory of the mine, and it is taught in economics class. If you own a gold mine, you have an incentive to mine the gold - to sell it. But if prices are low, you have an incentive to keep the ore in the ground and wait until prices go up. As prices are up right now, guess what the gold industry is busy doing?

That's right, they are mining gold. Production is going UP right now, to meed demand.

Not only that, but the "we buy gold" people are snapping up old gold jewelry and pieces and paying people cash for them. This in turn is melted down and increases the available supply.

Supply and demand - the basic market forces - apply to gold as well as anything else. The people hyping gold as an investment don't mention this. They want you to think that gold is "rare" or "limited" or that there is a finite supply. The reality is, there is a lot of gold in the world, and other than industrial applications and jewelry, it serves no real function other than as a quasi-currency. It's inherent value is really very low. The same is true of diamonds - despite what the deBeers people say.

When you buy gold as an investment, you hype up the price more - by saying it is worth something. This works fine, until folks start to question the value of it. If people stop buying, and there is more gold on the market than there are buyers, the price can plummet - dramatically.

I suspect sometime in 2012 or thereabouts, the supply of gold from various sources will increase to the point where prices will drop. Ones prices start dropping, people will start panic-selling their hordes (before the price drops more) and the sudden peak in gold prices will be a sudden valley.

There are other problems with gold as well. Storing it is difficult and costly. You'll either have to rent a safe-deposit box or buy a safe and risk theft. If you purchase physical gold or sell it, you'll have to pay transaction costs to a gold dealer. If you buy "paper gold" - shares in a gold company or some other paper transaction that represents physical gold, you are no better off than the person holding paper currency. The company claiming to keep gold on deposit for you could end up bankrupt and leave you with nothing. The "security" of owning a mineral is illusory.

If you want to "invest" in gold, a few years from now will be a better time to buy - perhaps in 2013 or 2014. But even then, as a long-term investment, it will still suck. Study the diagram above and think about the poor SOB who bought gold in 1982 and where he was in 2002, twenty years later. If you put your money in gold in 1982, as opposed to the stock market, you'd come out way behind - even taking into account the "black Fridays" and other setbacks the market has had since then.

When someone starts hyping an investment on television, you should be skeptical. If something was such a good investment, they would not be hyping it on television - they'd be investing in it themselves. That should be readily apparent to anyone. Why sell the goose that laid the golden egg?

Don't fall for investment scams like this. Don't buy gold. You'll get burned in the long run.

NOTE: I am re-posting this, as I am receiving SPAM comments from people hyping websites. I am deleting the original post and now have comments moderation turned ON.