Friday, July 2, 2010

The Gold Frenzy

By Bert Whitehead, M.B.A., J.D.

These blogs are intermittent because I only write them when a topic is raised by a client. Clients have recently been asking about Gold, and it’s been in the news since the value has increased to over $1,200/ounce. This is an actual response to a recent client inquiry (edited as appropriate).

Dear Bert,

Please give me your thoughts on reducing the ladder to a more frugal level, and buying gold with the difference. If a person were to buy, say $1mm in gold, would you think storing it in say 5 different safe deposit boxes would make sense?

Hi Joe,

Of course it is your money, so I can advise on whatever you decide to do. I also know that you realize that you tend to be impulsive, and have a knee-jerk reaction to market volatility. This is the reason, I assume, why you emailed me – and I am honored that you do respect my opinion. Now I’ll tell you why I think putting that much money in gold would be a stupid thing to do…

As an investment, gold never has much glitter. It isn’t really an investment, because it can’t be capitalized for growth like bonds or productive equity assets in your portfolio– any profit is based on speculation because gold doesn’t earn anything. Especially in recent years, it has been very volatile because you can now buy ETFs (exchange traded funds), which actually hold gold. As a result, speculators have been alternately dumping money in and pulling it out in sudden unpredictable moves, since they don’t have to take possession of the gold itself.

As an inflation hedge, gold has a terrible record. From 1980-2000, gold prices were essentially flat. Yet, inflation was up 3.7% per year, cutting the value of the dollar in half during that period. This is because we are now experiencing world-wide inflation. Gold can hedge the dollar, but only in relation to other currencies. As we continue growing into a worldwide economy, the dollar moves much more in synch with other currencies, and gold’s value during inflationary times doesn’t protect against worldwide inflation.

As a deflation hedge, selling Treasury bonds to buy gold would leave you extremely vulnerable to deflation, which is the primary global concern right now. If the US dollar were to drop so that it was virtually worthless, you might think that gold would become the substitute currency. The problem is that anarchy would likely erupt, and guns trump gold. So you should plan on having guns and ammo, because you wouldn’t be able to count on the government to protect you.

You could move to another country, and this is a reason why you might consider holding gold. You could take your gold and run if you or your family became vulnerable to adverse governmental action. Your accounts would be frozen, and the only wealth you could transfer with you to someplace else would be your gold. Many people who distrust the government expect that guns would be outlawed, so in a severe social/economic shift you could at least have transferable wealth (assuming there was a country left which wasn’t in anarchy). This situation would likely be endogenous, where one was accused of a crime, or the IRS decided to pick on you and come after all your assets.

There are practical obstacles: Many of my clients, and that includes me, feel more secure having some wealth that is not dependent on the benevolence of our government and their management of the economy. But there are limits = $1,000,000 in gold would weigh over 50 lbs.! That would be a problem to lug across the border!

The US dollar is the world’s reserve currency, which has a unique status and advantage. No other currency (euro, Yuan, franc, pound, etc.) carries enough respect to challenge the dollar…and none of them have enough depth to support world commerce. So where does the smart money run when the world economy gets dicey? The Arabs, Swiss, Chinese, etc. all buy Treasuries, which is why your bond ladder’s current value has been rising so quickly in recent weeks!

Basically, Joe, you already hold the best investment you can have in these fragile times. To hedge inflation, which I reckon we will be worrying about in 6-12 months, think about making sure you have some super 4.75% 30 year fixed mortgages!!

I hope this is helpful.

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY., as well as the blog editing by Susan Stanley

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