Gold may begin to lose its luster


Gold has been a stellar investment for the past 10 years and is perceived by many to be a superior investment relative to common stocks. It has increased from approximately $300 per ounce a decade ago to nearly $1,400 today, while the stock market has had virtually no price gain over that period, with dividends averaging 2% per year. Given this record, it is understandable why many people have a strong affinity towards gold at the present time. However, looking forward I believe it would be prudent to exercise caution with regard to further investments in gold.
Gold has had a long history as a store of value, which essentially means it should be a good inflation hedge. For example, if a country is experiencing major inflation, the currency tends to be worth less, while gold would tend to hold its purchasing power. While gold is an inflation hedge in theory, because of its high price volatility, it does not always maintain its purchasing power. Clearly, the last 10 years have been a wonderful time for gold, but the prior 20-year period was terrible. In 1980 the price of gold peaked at $850 per ounce, and for much of the next 20 years, it hovered around the $300 per ounce range.
The proponents for gold will argue that the world is different today and gold should trade higher. That is certainly true and explains why gold is at $1400 not $300 per ounce, but does not necessarily imply that gold should be a good investment currently. The past 10 years have resulted in strong price performances for most commodities in addition to gold, such as oil, silver and the grains. This is due to the tremendous growth occurring in newly developed countries, such as China, India and Brazil, and also a relatively weak dollar. While these trends should persist, they are widely anticipated and reflected in current prices. In addition, high prices will attract more supply, which will limit future price increases.

Clearly, underlying demand for gold, especially from Asia, has been strong but in addition, there has been increased investor demand. Currently, there is over $50 billion in gold exchange-traded funds, in which the growth over the past five years has been explosive. In some places, such as Boca Raton, Fla., gold can be purchased from a vending machine. If this investor demand begins to wane, the risk of a price drop becomes significant.
Another consideration is that gold offers no income. Therefore, I believe investing in resource-related stocks, such as mining- and energy-related companies, which have profits, is preferable to investing in the underlying commodity. These companies have performed well recently, so I would be cautious about adding money now, though the long term outlook is favorable. The same concept applies to a real estate investor, who is normally better off with an income-producing property than investing in raw land. For a more conservative investor, Treasury Inflation Protected Securities (Tips) offer a less volatile inflation hedge relative to gold.
Gold may be suitable for a short-term trader, where income is not important. For a longer-term investor, the alternatives just mentioned would likely be preferable.