Should I Buy Gold?
What you should know before buying gold
Buying gold is not for the faint of heart. First, most investors enter the market rather late, after prices hit historically high levels. The price of gold has been down since it hit its peak of $1,895 in 2011.
The main reason why people buy gold is to preserve their money during an economic crisis. Gold is the best hedge against a potential stock market crash, according to research done by Trinity College. It found that gold prices increased dramatically for 15 days after a crash. Frightened investors panicked, sold their stocks, and bought gold, but after the 15 days, gold prices lost value against rebounding stock prices.
Gold has been used as a form of currency since 643 BC, so people believe that it will hold its value better than paper currency. But gold hasn't been used as money since President Nixon took the world off the gold standard in 1973. The physical supply of gold is relatively inelastic in the short-term with regard to price, so the supply will not increase even if the price does. This is because gold must be mined, and it takes a long time to find new mines and get the gold out of the ground.
Limited supply makes the gold market both thin and volatile when demand grows sharply. That means there are few traders, and they have a lot of influence in the market, including the ability to drive prices up quickly once it looks like there is an upward trend. At a certain point, gold can quickly become a bubble, and when the bubble bursts, you can lose a bundle.
Gold, more than any other investment, has the traits to become an asset bubble because it's very difficult to determine its real intrinsic value. Stocks have underlying earnings, and real estate has rental equivalents. The only underlying value of gold is its cost to mine. Even that is difficult to determine since miners say it's anywhere between $500 to $800 an ounce.
Who Should Buy Gold
The gold market is most appropriate for arbitrageurs who can take advantage of short-term price changes regardless of the level of the price of the metal. These are professional investors who have enough money to ride out any dramatic ups or downs. It should be a warning for the average investor, who will be at the mercy of the arbitrage.
That's why gold prices rose so fast in 2011. When many investors believe gold is a safe haven, and the global economy is uncertain, gold's rise becomes a self-fulfilling prophecy. Like any other bubble, however, it's nearly impossible to guess how far it will rise, or for how long. Bubbles usually last longer than you think they will, and they end quicker than you can imagine.
How It Affects You
Most financial planners will tell you that the best hedge during turbulent times is not gold or any other single asset. Instead, you should have a diversified portfolio that meets your goals. Your asset allocation should support those goals, but even a safely-structured portfolio should have no more than 10% of its assets in gold.
If you want to sleep well at night, putting a substantial portion of your portfolio into gold is not the way to do it. Most financial planners advise putting a small percentage of your investments into gold and other commodities to achieve diversification.