By: Anna Wroblewska
Is it better to sell the gold you find (preferably to finance your prospecting habit), or to hang onto it for later? Gold has been a popular financial tool for millennia, and the reasons we as people have continued to demand it are as varied as we are.
If you’re interested in thinking of gold as an investment, there are a few key arguments in favor – and a few words of caution. Investing is inherently different from trading, which is a short-term activity intended to generate a profit. This article won’t tell you whether to buy or sell gold right now, but it will give you a brief overview of the key benefits and risks to using gold as an investment.
First: Remember that your mileage may vary
Two important caveats before we get started: all the numbers here are based on the spot price of gold – that is, the price of an ounce of pure gold on the open market – and the examples ignore all the other costs and fees involved in investing.
Why is this so important? Well, the value of your prospected gold will vary depending on its form, purity, and who you sell it to. In other words, the spot price is more of an indicator of value than a real price you can obtain. You might get less – or, if you’re lucky enough to be in possession of gold nuggets or have crafted mementos from your raw gold, you may be able to get more.
You might also encounter additional costs in selling gold (outside of the investments you’ve already made as a prospector), including professional assays, commissions, and other fees. If you have investment accounts, you may also need to pay taxes and investment-related fees, which can and will affect your final performance.
In short, it’s important to understand the factors we’ll talk about and how they can affect gold as an investment, but the numbers in this article shouldn’t be taken as gospel. Your mileage, as the saying goes, may vary.
Why do people invest in gold?
There are three key arguments in favor of gold as an investment, and all are grounded in the idea of risk management.
As a physical asset, gold carries less direct exposure to the financial system than the money in your bank account, and it’s more or less tradable worldwide (the last resort argument). Gold could also be considered a diversifying element in your overall portfolio of assets (the diversification argument). Finally, gold is thought to provide protection from inflation, which reduces the purchasing power of currency over time (the inflation hedge argument).
Let’s examine each in turn.
Gold as a last resort
Imagine it’s a time of deep financial crisis. The value of your home has plummeted along with your investment account. Maybe there was a relatively small but emotionally significant run on your bank, which is now owned by someone else, and several other financial institutions have either been bailed out or propped up by the government.
You might remember some of these stories from the financial crisis and its aftermath, which started in 2008.
These types of risks are the drivers of the “last resort” approach to gold as an investment. As we all know now, the stability of our economy can seem to shift on a dime – and even if things don’t go completely south, your investments or home could lose a lot of value. If you need cash in a situation like this, it could be hard to sell without subjecting yourself to serious losses.
In these situations, the thinking goes, gold could offer some protection. After all, gold is pretty much universally considered a valuable asset and is relatively easy to trade – both among specialist dealers and non-specialists alike.
From an investment standpoint, the value of gold surged between 2008 and 2012, growing at an average compound annual rate of over 16%. That means that a $10,000 investment in gold in 2008 would have been worth over $18,000 by the end of the period.
But that performance doesn’t tell the whole story. In the recession of the early 1980s, the price of gold fell before making only a partial recovery in 1982. Gold prices continued to decline until the early 2000s, which marked the beginning of a multi-year bull market for gold. So, while gold performed admirably during the last recession, it isn’t by any means a guarantee of future performance.
Key takeaway: If you’re reading this with the gold in your cupboard in mind – and especially if you were burned by the last recession – then you might be inclined to think of gold as a fairly low-cost way to reduce your risk in the event of another serious crash. In the worst case scenario, it could provide value as a tradable security. Just remember that the value of gold isn’t guaranteed, and that you might not get the protective benefits you were expecting– the market for gold, just like any other market, can surprise us.
Gold as a diversifier
Gold moves on a global market, and its price has many factors. Demand by manufacturers that use gold, global economic conditions, inflation risks in different regions, and currency trends all have an impact on the gold price. These factors also influence assets like stocks and bonds, but they’ll tend to have a different effect on them. From a diversification standpoint, that’s a good thing: by reacting in different ways to the same event, different assets in the same portfolio can help offset each other and reduce risk.
Let’s say you invested $10,000 in the US Stock market in 2008. By July 2017, you’d have almost $20,900, but in your worst year you would have lost about 37%. If you put 10% of your money into gold instead, you’d have about $20,800 today – just a tiny bit less – but your worst year would have seen a loss of just 32%.
But it’s critical to remember that gold as a diversifier doesn’t mean the gold price is always going up. The price of gold can and does vary – sometimes by a lot. If it happens to fall at the same time as all your other investments, it could magnify your losses instead of mitigating them.
Key takeaway: Gold can offer diversification benefits when it’s part of a larger portfolio of assets. This can help reduce the overall risk to your portfolio without costing you much in terms of returns. Just remember that this doesn’t mean gold will always rise, nor does it mean that the price of gold will rise when the value of your other assets falls.
Gold for inflation protection
The idea behind gold as a hedge (or protector) against inflation is that it will maintain its value better than money. If the purchasing power of money falls over time but the price of gold rises faster than the inflation rate, it’s keeping its value in a way that your dollars and cents aren’t.
It’s a common argument in favor of gold, but it’s actually the weakest reason to think of gold as an investment. The effectiveness of gold as an inflation defense varies quite a lot. Between 1972 to 2017, for example, gold returned an average of 3.43% per year to investors after accounting for inflation. It not only beat inflation but added more value, making it look like a pretty good investment.
But the time scale is important. The US Treasury dropped the gold standard in 1971, which had effectively held down the price of gold for decades. After being “let loose,” the price of gold exploded in the 1970s (though this wasn’t only because of the dollar), growing at an average annual rate of 23% - after inflation!
Between 1980 and July 2017, on the other hand, the post-inflation return turned negative. And if you look at gold’s worst period in the post-1980 era, it’s miserable: a $10,000 gold investment would have lost $6,200 in that time period.
All this is to say that gold can, in some situations and time periods, offer a great way to preserve against inflation. But judging from the historical record, it’s probably more effective over longer periods, and it might not be the best go-to method. If you’re worried about inflation, there are other ways to protect yourself from it that are more reliable and provide better short-term results than gold.
Key takeaway: Over the long run, gold has been a pretty good way to protect against inflation, but part of that result has been driven by major spikes in the price of gold during short periods of time. If you’re looking to protect yourself from rising prices in the short run, it might not be the most effective tool.
Getting to the right answer
All of this might seem unnecessarily complicated: if you enjoy prospecting and you enjoy hanging onto the fruits of your labor, then there’s no real reason to worry about what gold can do for your portfolio over the long run.
But if you’re interested in thinking about gold as an investment there are benefits to keeping it, especially if you remain aware that it’s not a guaranteed path to riches, or even to preserving your riches. There is nothing simple or one-sided about gold: the price varies, sometimes wildly, and its effectiveness as an investment depends on several risks and complicated factors – not to mention your individual financial position and investments.
Like prospecting or any other undertaking, thinking like an investor requires patience, prudence, and the ability to think about risk versus reward. Armed with those traits and the right information, you can go in with your eyes wide open.
Anna B. Wroblewska is a widely syndicated financial writer who specializes in making complicated financial subjects accessible (and interesting). You can find her online at www.auguryconsulting.com.