— A weak economy and a cloudy outlook in the financial markets have sent investors flocking to gold. Before you take the plunge with what’s left of your savings, take a closer look at what’s making the metal sparkle.
Investment managers shouldn't be scoffing at anyone these days. And you don't have to be a "weirdo gold bug" to benefit from buying precious metals.
Investors have been piling into gold for good reason, and there’s nothing wrong with the logic behind the case for buying. Gold has traditionally done very well in times of financial upheaval because of its perceived safety.
The price of gold typically rises when the value of paper money falls. As the Federal Reserve and U.S. government have flooded the world with paper money to try to revive the global economy, gold bulls argue that it’s only a matter of time before inflation returns. Surging prices for goods also push gold prices higher.
All of these conditions have helped spark big demand for gold, which creates additional upward pressure on prices. But keep in mind that gold prices can fall sharply with little notice. So while it may provide a useful hedge, it’s not a great place to stash your entire nest egg.
Investors who did so in the late 1970s learned the hard way why gold can be so risky. As inflation raged, gold prices doubled in the 10 months that ended in October 1979. Governments appeared powerless to stop the corrosive price spiral. Interest rates remained high because anyone lending paper money worried about its rapid loss of value. By January 1980, gold prices had doubled again to hit $850 an ounce.
But investors began fleeing gold two years before inflation was fully tamed and the economy had recovered. The collapse of gold prices left gold investors badly burned for a long time.
It would take nearly 20 years to reach the 1980 peak again. During that time, gold had lost 70 percent of its value from peak to trough.
Despite its reputation as a great hedge against inflation, gold hasn’t done a very good job there either. Let’s say you had waited for the crash after the 1980 bubble and bought at the low of $481.50 on March 18, 1980. Adjusted for inflation, that ounce of gold should be worth $1,265.43 in 2009 dollars.
But the price of gold has yet to hit that mark. (In just the last few weeks, the price of gold has fallen 8 percent from its peak of $1217.40)
The Fed's unprecedented moves to keep short-term interest rates at zero by flooding the system with cash is certainly cause for concern.
There’s little evidence of inflation in the economy today; the large excess capacity in housing, manufacturing capacity and labor markets are creating a big damper on prices. But if central bankers wait too long to mop up all that money, it could spark a fresh outbreak of inflation.
If you’re worried about inflation, there may be better ways to hedge. The price of metals like copper will likely rise if the global economy picks up and demand increases, especially in the developing world. (The same is true for oil.) For individual investors, there are a number of funds or ETFs that offer you a diversified basket of commodities.
If you’re worried about hedging against a more serious financial calamity, it’s far from clear that gold would be a safe place to protect wealth. Some readers have suggested that a rapid decline in the dollar, for example, could bring a return to the conditions a century ago when countries pegged the value of their currency to a fixed weight in gold.
That's highly unlikely. Countries dropped the gold standard because as global trade imbalances increased, floating rate currencies provided an important source of relief from the economic pressures that build sometimes between countries or regions. (Those cross-border pressures are now weighing on European central bankers, for example, as they try to coordinate policy among the many different economies that share the euro.)
All of the above applies to investing in gold. If you're worried about an end-of-the-world, global financial collapse creating a dystopia worthy of a Hollywood blockbuster, stashing gold in a 401(k) may not be your best strategy. For one thing, when you go to get your gold, you'll owe taxes and penalties, assuming there's still a government to collect them. If that's your main concern, you're better off burying some gold coins in the back yard. (We'd never call you a "weirdo" for doing so, but that's not exactly what we'd call investing in gold.)
It’s true that if we were to have another global financial panic, it’s likely that the price of gold would surge. If you’re worried that might happen, by all means park some of your savings in gold so you’ll sleep better at night. But before you do, take stock of the risk that you may lose money if the economy continues to improve and inflation remains tame.