Gold as investment has been discussed extensively the past few years leaving investors questioning whether or not to invest in this commodity. By breaking down the reasons investors buy Gold and looking at historical price trends, we hope to help explain why Gold is not truly an investment, but rather it is a speculation. First, let us consider that the gold market recently did something it hadn’t done since 1980. It fell 13% in two days and is now down dramatically from its 2011 highs. Let’s examine what caused this recent sell-off and determine if investors should be purchasing gold.
The reason for the recent sharp decline in gold prices is twofold. First, major analysts lowered their predictions for gold prices. Then, once gold fell to $1,550 an ounce, the market was hit with a huge backlog of sell stop orders. The result was once gold broke $1550 an ounce, it went down quickly on the weight of these stop loss orders.
A reduction in global inflation also played a role. Recent Producer Price Index (PPI) numbers have beenweaker than expected. Base metals prices, oil prices, and many other barometers of the global economy, including the agricultural markets, all have come down steadily the last few months. This data indicates inflation may actually be weaker than expected. If inflation is weaker than expected, demand for gold should continue to fall.
Looking back, the price of gold surged for years, and then has been trading in a range of $1800 to $1450 an ounce for two years. In scenarios like this, when market prices have surged and then range-trade, there can be an iceberg of sell stop orders sitting beneath this range. Speculative players wanted to protect their early profits. A negative feedback cycle developed, and the gold market collapsed in two quick days.
At Zacks Investment Management we continue to believe that gold is not a financial asset. Gold doesn’t generate any income and it doesn’t pay a dividend. Thus, we view it not as an investment but as a speculation. You shouldn’t own a large amount of gold in your portfolio.
So why are there so many investors who own gold, and so many mutual funds who allocate to gold? Generally, there are three reasons investors buy gold: Store of Value, Hedge Against Inflation, and Hedge Versus the Debasement of Currency. We believe these reasons are flawed gold’s value completely depends on other people to act in a specific manner for it to go up in price.
Historically, gold has been known as an effective store of value, but this has gone in and out of favor. The price of gold has risen over the last ten years, but prior to that, it did absolutely nothing for a long period of time, even during times of high inflation. In the 1980’s, gold wasn’t considered a great store of value; now it is. The only thing that has intrinsically changed is the perception of what the future might bring.
Some brokers or portfolio managers will tell you that gold should be a part of everyone’s portfolio because it’s just a good way to diversify assets. This is one point of view, but an outdated way of thinking. Yes, it meant something when gold was inversely correlated with the equity markets. But with assets now correlating together via gold-based exchange-traded funds (ETFs), this view has less and less credence. ETfs make it easier than ever to put your money into gold. Fifteen years ago, you would have had to buy gold futures, but now gold ETFs give easy exposure. However, just because it’s easier to put gold into your portfolio doesn’t make it a good idea. At the end of the day, the price of gold is completely reliant on people’s preferences. As those preferences change, just as they have recently, the price of gold falls.
In short, gold prices are driven by ‘animal spirits,’ not any sort of evaluation of its intrinsic value. There’s no real reason for gold to go up — or down — in value. That’s not to say you should think of it in terms of being ‘bullish’ or ‘bearish,’ but recognize gold as something other than an investment – it is a speculation.
Gold is something you can hold in your hand and it looks very pretty. Buying gold is very much like buying an antique or an expensive piece of artwork. But think of it this way: as an investor, you wouldn’t buy a nice painting or an antique as a means of generating returns. The value of these items is completely reliant on the perception of value of that painting, that antique, that rock.
The huge increase in the price of gold reminds us of the late 1990s. Recall the technology bubble that was driven by all the IPO activity for technology companies that weren’t generating any earnings. People believed these corporations were intrinsically valuable and bought them up, but without being grounded to earnings or income most of these stocks eventually collapsed.
This is an example of when an investment became a speculation. In contrast, solid companies that report growing earnings or pay a dividend are true investments. The intrinsic value is measurable with these firms, and as such they are more sensible – and far less risky – assets to own.
When everyone who has been parking their assets in gold decides it would be more productive to go into equities or other investments, the price of gold will reverse itself. Once people decide they want to stop buying the pretty rock, the price of gold will fall. What is driving the price of gold is not fundamentals, not income streams, but fluctuations and perceptions about expectations. It’s essentially a speculation on mass psychology, and that, quite simply, cannot be predicted.
Disclosure: This communication is for informational purposes only and nothing herein should be construed as a solicitation, recommendation or an offer to buy or sell any securities or product, and does not constitute legal or tax advice. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional investment, legal, tax, or accounting counsel.
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