Golden Glitter

Ric Edelman has an interesting assertion on the hype on gold.

The Truth about Gold
What the pundits aren’t telling you

Many are hyping gold as the must-have investment of the day — with promoters regularly saying that gold is a profitable investment that hedges against inflation while protecting against a declining dollar. Sounds great!

Too bad the hype is wrong.

The truth is that gold is a speculative investment — one whose returns are not guaranteed. Consider the last time we encountered a gold rush, in the late 1970s and early 1980s. At the time, inflation was rampant, the government had bailed out Chrysler with a $1.5 billion loan and investors were flocking to gold while the media egged them on — pushing up the price to a then-record of $850/ounce, according to the New York Mercantile Exchange. (Remind you of any behavior you’ve been seeing lately?)

At the time, gold seemed like a can’t miss investment. But like all investment fads, the run-up in gold prices didn’t last. After prices peaked in January 1980, prices then dropped for 235 months — that’s a bear market of almost 20 years! — finally bottoming out at $252.80/ounce in July 1999. It took another 7½ years for prices to reach their January 1980 high. Can you imagine waiting 27 years to recoup your initial investment?

Making the situation worse is the fact that gold pays no dividends, interest or income — unlike stocks, bonds and real estate. Stocks can split (turning one share into two shares), but gold never does. Thus, over that 20-year period, there was utterly no gain whatsoever to be had. Worse, some people had to pay fees to store the stuff.

But doesn’t gold help you keep up with inflation? Not necessarily. Consider this: From January 1, 1979, through December 31, 1984, the Consumer Price Index rose 7.6% annually — but gold prices rose only 4.1% each year. Meanwhile, the S&P 500 Stock Index* rose 15.4% annually.

Okay, if gold isn’t certain to protect against inflation or provide any sort of guaranteed return, will it protect you against a weak dollar?

Again, not necessarily. Gold and the dollar are not negatively correlated - meaning, one does not rise merely because the other falls. In fact, over the past 40 years, gold moved in the opposite direction of the dollar only 20% of the time, according to Oppenheimer & Co. That’s hardly a sure bet. For instance, from December 31, 1987, through September 1, 1992, the dollar declined 8.3%, according to Bloomberg. If you had bought gold as protection, you’d have been hurt, not helped: Over that same period, gold prices declined 29%!

This is not to say that gold doesn’t have a place in your portfolio — it’s just that the metal should comprise only a small part of it, along with other natural resources. Consider the S&P North American Natural Resources Sector Index, which tracks oil and gas and consumable fuels (64.9% of the index); energy equipment and services companies (15.6%); paper and forest (1.5%); containers and packaging (2.7%); and metals and mining (14.3%).

That last category tracks gold as a commodity and, just as importantly, it tracks companies that mine gold. (If you’re infatuated with the idea of buying gold at $1,100/ounce, you’d love investing in a company that digs gold out of the earth at just $300/ounce!) Of course, such metal and mining operations don’t just excavate gold: They also extract silver, platinum, nickel, copper and iron ore — meaning they diversify their operations to hedge against fluctuating commodities prices, just like you should be doing.

And, believe it or not, as of October 31, 2009, the NANRS Index was outperforming gold for the year — up 28.1% versus 18.5% for the SPDR Gold ETF.

The message here is not to load up on natural resources, for that would be just as speculative as loading up on gold itself. Rather, the better approach for protecting against inflation and a falling dollar is to invest in a broadly diversified portfolio.

So don’t hop on the gold bandwagon hoping for a lustrous portfolio. As Shakespeare said, “All that glisters is not gold.” And sometimes that includes gold.