FINANCIAL LIFE | FALL 2010 EFFECTThe Modern Day Gold Rush
by Steve Bien
More and more radio and TV ads are touting the great fortunes to be made in gold. With many of the major stock market indices having average 10-year returns in negative territory, it’s no wonder people are looking for alternative investments. However, before you jump at the so called “buying opportunity of a lifetime,” there are a few things you should understand about gold.
First of all, whether to buy stocks or gold should not be an “either/or” decision. Most people should have exposure to both stocks and gold, as well as other traditional asset classes, such as cash, bonds, and real estate.
Rushing for the gold
Gold has had an exceptional run up in price recently. According to Bloomberg, over the last five years, gold soared from roughly $400 per ounce to around $1,200 per ounce. So, are the masses making the same mistakes made in the late 90s with technology stocks: buying at the peak? Only time will tell. However, I will point out that according to a November 2009 Wall Street Journal (WSJ) article, gold would have to reach approximately $2,300 an ounce to hit its high from January 1980, on an inflation-adjusted basis. This would require it to almost double from where it is currently.
Gold has had an interesting historical connection to the markets. In an effort to stabilize the U.S. dollar after the stock market crash in 1929, President Franklin Delano Roosevelt gave an executive order to confiscate gold coins owned by American citizens (all but $100 worth per individual). Other than collectors of rare coins, Americans were required to turn in their gold coins to the Federal Reserve Bank or face large fines and/or jail sentences. The government then melted the confiscated coins into bars and devalued the dollar, which raised gold’s value by nearly 75 percent.
Fiat currencies
Historically, most national currencies were based on physical commodities such as gold or silver. Today, most are considered fiat currencies, that is, paper that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Fiat money is based solely on faith.
At the end of World War II, the Bretton Woods Accord fixed currencies to the U.S. dollar instead of gold; the dollar in turn was pegged to gold at $35 per ounce. This system remained in place until 1971, when the U.S. dollar could no longer hold the value of the pegged rate. Since then, we’ve had a floating exchange rate system.
Fiat currencies have had a long history of failure. To understand the reason, look no further than our national debt. Technically, the United States could print 10 trillion dollar bills and hand them out. But the implications of such actions are obvious—if the dollar is not linked to any physical reserve, it risks becoming worthless. If people lose faith in our nation’s paper currency, the dollar will no longer hold any value.
Investment options
Buying gold is thought to be one method of helping protect portfolios. Most think inflation is around the corner because the government has been printing massive amounts of money to stimulate our economy. That same November 2009 WSJ article went on to say that if the U.S. dollar were back on the gold standard, then gold would have to be priced at $7,648 an ounce in order to fully back all the dollars in circulation.
For those interested in gaining exposure to gold, there are avenues other than having it delivered to your house. For example, there are exchange traded funds (ETFs) that hold actual gold bullion, ETFs that hold futures contracts linked to the price of gold, and ETFs that hold stock in gold mining companies.
I believe gold has value because people perceive it to have value. It has very little industrial use. Once mined, gold just continues to circulate, though it may change form from jewelry to bullion and back again. The bright side of gold is that it doesn’t go up in smoke like the oil products burned in a car engine.
But before being bit by the gold bug, work with a financial professional to determine whether investing in gold in some form is an appropriate strategy for you.
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