History has shown that gold has been sensitive, whether that comes from inflation, production, or availability. The mere perception that world prices may be about to rise has been enough to drive up its value. And with rising prices we have generally seen higher interest rates. Therefore, once inflation has become well established, investors have tended to switch out of gold into high-yielding debt instruments, such as bonds.
An example of these conflicting, inflation-related trends occurred in the late 1970s and early 1980s. First, there was the oil crisis and concern over the onset of rising prices, which caused a major hike in the value of gold. Then, in relatively short order, the market gave away most of those gains as inflation actually set in and investors opted for the high interest rates that became available in the bond market.Another gold noteworthy characteristic is its tendency to react to crises. Whenever there has been a financial meltdown or an international conflict, the demand for gold has increased. Even though these scenarios differ from inflation, they share the common effect of threatening the underlying values of the currencies involved.
On occasion, both significant characteristics have impacted the gold market at the same time. One such example occurred in 2007, a year in which gold’s value rose by 40%. During that year, the emerging economies of India and China were buying up resources at a frantic rate, and commodity prices were rising rapidly. At the same time, there was an international crisis in the Middle East involving two limited wars and the threat of an attack on Iran’s nuclear facilities. This combination of circumstances represented an ideal environment for the sharp increase in the price of gold.
There have also been times in the past when gold has been virtually eliminated as a speculative investment. This has resulted when countries have adopted the gold standard by tying their currencies to their gold reserves.
Furthermore, huge trades have also affected the market. These have usually involved transactions by national treasuries and institutions such as the International Monetary Fund.
Despite the attendant risks and the rapid price variations that have occasionally been involved, there are a number of reasons for gold to be a vital component of a well-balanced investment portfolio, particularly as an effective hedge against both inflation and international crises.
Holding gold can also serve as a hedge against other currency threats. The dollar could lose value if the Euro was to gain more prominence as the international legal-tender of choice. Or you could hold gold because the commodity has performed well during periods when stock prices have declined. One such example occurred after President Nixon created a free market price for gold in 1971 by breaking its link to the dollar. Over the next nine years -- while the stock market failed to even keep up with the rate of inflation -- the price of gold soared by over 600%.
Based on the supply and demand, you could simply just invest in the metal itself, rarity always commands a premium. As the world has seen more economies grow and become productive, there has been a greater demand for all basic resources. One of the largest consumers of gold in the early years of the 21st century, for instance, was the emerging economy of India.
There is no guarantee that history will repeat itself, but if you are inclined to add gold to your portfolio, there are several ways you can do so, and they involve various levels of risk.
One of the most secure ways would be to simply own it outright. In this respect it would be a good idea to avoid rare coins or anything else you don’t fully understand. The South African Krugerrand is recognized world-wide as one prudent investment of choice. You can investigate the reliability of your dealer through the internet and check out his pricing by doing some comparison shopping.
If you choose this route, you may be able to purchase on margin, which means you would be borrowing part of your investment. Be aware, however, that, in such instances, a drop in the price could be disastrous.
Another option would be to consider a mutual fund or exchange traded fund (ETF) that invests in gold bullion and/or in the somewhat riskier shares of gold mining companies.
Mutual funds charge front end load fees around 5% with minimum investments of approximately $1,000. Their operating expense ratios usually run from 1% to 1½%. Two such funds you could consider would be Van Eck Intnl. Investors Gold A and Oppenheimer Gold & Special Minerals.
The minimum investments of ETFs are quite low and their expense ratios are generally below 1%. Inasmuch as they are not as closely regulated as mutual funds, they may be somewhat riskier. At the same time, their rewards potential may be greater. Two examples of ETF’s to consider would be i Shares COMEX Gold Trust and SPDR Gold Trust.
Another way you could invest in gold would be to make a direct investment in the common stock of one or more gold mining companies. Here, however, the question of ongoing corporate stability could become an added concern. Risks could be posed not only by a company’s leadership but also by its mining and exploration activities. If you are a new investor, the day-to-day management offered by a mutual fund or ETF might be more appropriate.
The riskiest option would be to invest in gold futures, either directly or through a fund. In this market, you would be betting on what the price of gold would be at some future point. If the gamble doesn’t work out, every penny could be lost.
In deciding on the best approach for yourself, your financial advisor should be able to match your needs and desires to the appropriate alternative, although the final decision should, of course, be yours. Just understand, all that glitters is not gold.