#9 – Should I Buy Gold?

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A few months ago, someone asked me “Should I Buy Gold”? I promised on The Retirement Manifesto Facebook page I would answer that question this week, so here goes:

It depends.  Please bare with me as I explain.

No investment should be made without considering your overall portfolio, objectives, asset allocation, and how any new investment “fits” in the overall plan. I’d suggest you start with a more basic review of your portfolio and objectives before making this decision. I’m going to send another post later this week addressing this “overall” view of Personal Finance. However, for the benefit of my inquirer, a few of my thoughts are summarized below.

Is there a place for gold? Absolutely, though some would argue Platinum or Silver would be a better choice at the current price relationship to gold (if you’re not familiar with these price relationships and ratios, I suggest you study them before purchasing any gold). So, let’s change “Gold” to “Precious Metals”. Are there down sounds of Precious Metals? Absolutely.

Here, then, are the basic arguments for and against Precious Metals. I won’t attempt to support or refute these arguments, as I believe each reader should form their own opinion. Also, to keep this post to a manageable length, I won’t get into the various means one could pursue to “own precious metals”. Suffice it to say, you can either buy physical (e.g., coins), Electronicslly Traded Funds (ETF’s), or equity/stock in companies that mine precious metals. I will draw some basic conclusions at the close of the following summary:

Arguments For Precious Metals

1) Diversification. Every portfolio should attempt to diversify exposure among asset classes that are not “correlated” (meaning, they move to different rhythms and should offer some protection of a price decline across your entire portfolio at the same time. The following chart shows gold prices vs the S&P 500 over the last five years, and you can see they do tend to move independently of each other.

Gold price vs. S&P500

2) Currency & Inflation Hedge: If you believe the US Dollar is headed for decline, precious metals offer one means of “hedging” this risk. As a currency weakens, precious metals will increase. Regarding inflation, there are some who argue that precious metals will rise in a period of high inflation, protecting purchasing power. It should be noted that there are some who dispute this claim.

3) Economic Collapse Hedge: Media has had fun highlighting “Preppers”, or those that believe “TEOTWAWKI” (The End Of The World As We Know It) is at hand. True, precious metals could be a means of barter in the end times. As a Christian, I do believe there will ultimately be a dramatic change to life on our humble little planet. However, Precious metals will not be your salvation if/when such an event does occur.

Arguments Against Precious Metals

1) No Dividend Revenue. Warren Buffet (one of the greatest investors of all time) is strongly against precious metals as an investment, and one of his strongest arguments is that it doesn’t provide an income (such as dividends or interest). In the low interest rate such as we’re facing now, this is a smaller factor since the money you’d be investing in precious metals would have a lower “opportunity cost” (e.g., if you had it in a bank savings account it would earn a historically low interest rate anyway).

2) Low long term returns:  relative to equities (stocks), precious metals have historically been a poor investment choice over the long term.

3) It’s only worth what the next person will pay:  there’s no intrinsic value in precious metal, and it’s worth could decline if folks reduce the amount of money they invest in this commodity.  Also, some would argue it’s potentially a poor “bartering” item in an economic collapse if folks decide true consumables (e.g., toilet paper) are worth more than a metal coin which doesn’t cover true physical needs (e.g., food).

Conclusions

Every investor must make their own decision on precious metals.  I’d recommend that if you do decide to invest, the pricing at the moment is lower than it’s been in the recent past.  Consider precious metals versus your other investment options, which are currently trading at prices higher than historical averages.  Many argue that stocks/equities are over-valued and due for a correction, and bonds have risk if interest rates rise (bonds fall in value when interest rates rise). Regardless of your view, precious metals should not comprise a signficant percentage of your portfolio.  A 5-10% allocation is a reasonable allocation.

Personally, we own silver and gold (in all three forms:  bullion, ETF’s, and stocks of miners), and we’ve recently added a bit to our position.  We’ve determined target price levels, and when precious metals fall below our target we add small %’s of our allocation, taking the funds out of equities and/or bonds (“rebalancing”).  Our total allocation is ~5% of our portfolio, and I’m considering increasing our position slightly if there are future reductions in price.  10% will be our maximum allocation to precious metals, and we’ll only achieve that level if there is a 10% reduction in prices from current levels.  Similarly, if prices rise we will sell increments that we already own as certain price targets are realized.

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7 comments

  1. As an investor in the precious metal sector since a few years now, I believe that something big is going to happen in this sector according to many experts like Bo Polny or Handy Hoffman. Even though Warren Buffet was a great trader and asset promoter, I don’t really take his analysis on this sector seriously because he did not do it at the same monetary and political situation as we are nowadays. Also Would I say that Silver is going to plow away the other precious metals because of it’s industrial indispensability; It is WAY undervalued and is the only smart investment in my opinion for the next years.

    Just my opinion (and some great analysts I follow)

    Phil Richard

    1. Phil, Precious metals has been an interesting asset class to monitor the past few years. I do agree there’s likely upside from here, and certainly provides a hedge against uncertain times. Unfortunately, none of us can know the future, which is why a diversified asset allocation approach is the path I’ve chosen with my personal investments. Time will tell! Thanks for your comment.

      1. So you HAVE been monitoring it lately… most likely that you know what I am talking about. But you are right, no one can tell the Future. We’ll get back to it in a few months then!

        Phil Richard

  2. Hey Fritz, I was checking in my portfolio lately and I remembered our conversation. You may easily guess what it is mostly made of, I want to know your opinion though. What do you think , as a long term investment such a an IRA, would be the best ratio between performance and security; investing in the physical asset or in the industry?

    Thanks in advance,

    Phil Richard

    P.S : I think we’re in! 🙂

  3. Phil, the timing of our discussion was prophetic. Precious metals have certainly enjoyed a revival, as they’re supposed to in times of volatility. This is exactly why a diversified portfolio should have exposure to precious metals. For me, I own a bit of physical metal (coins, bullion), some mining stocks via ETF’s, and some mutual funds. So, I have exposure to physical, sector, and miners. Diversified, as you’d expect! As far as your question between miners and physical, you’ll typically get more volatility, but potentially higher returns, owning the industry/miners. I’m equally weighted between both. Hope that helps!

  4. This is very informative, thanks Fritz. I own a small amount of both gold and silver and think that metals get a bad rap. Although the amount I own in tiny right now I’ll probably be getting more silver soon.

  5. One thing to consider is that the value of precious metals is somewhat dependent on the demand for these metals in manufacturing. For example, gold is an excellent conductor of electricity and so the demand for its use in electronics, computers, etc. is high at the moment. If someone were to find a way to fabricate a better conductor at a lower cost, the value of gold would plummet. It won’t always have the value it does today and its value won’t always go up and down based just on the volatility of the market.

    I’m looking to retire in the next year and stumbled on your blog. Thanks for all the information and inspiration. It’s given me a lot of great things to consider in my planning.

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