It’s January 2012 and Gold is at $1,738 an ounce. You bought it in January of 2001 for $266.20 an ounce. Over the last 11 years, your gold investment returned 552%! How do you feel?
You probably feel amazing. You probably feel like the smartest investor in the room. You probably feel like gold is one of the best investments you could own.
You talk to your friend, who also invested in gold, but instead of investing in the early 2000s, they invested January of 1980 when an ounce of gold was priced at $668. They bought after gold had risen from about $130 an ounce in 1976. They continue to hold gold for two decades. By January 2000, they decided they had enough and sold gold because it’s priced at $283.05 an ounce.
Your friend invested for 20 years and had a -58% return.
You start to wonder, “Is gold a good investment?”
It’s a fair question. I can’t imagine investing for 20 years and getting a -58% return. It’s tough enough to imagine investing for 10 years and getting a 0% rate of return, which happened with US stocks in the 2000s, known as “The Lost Decade.”
In the financial media and talking with friends, it frequently seems as though gold can be a tremendous investment. People will tell stories about how they made a ton of money in gold. The financial media will tell you it’s a great inflation hedge and people will flock to gold during times of distress.
While gold can have good periods of time, it’s been a fairly poor performer over longer periods of time. In fact, it is not always the best inflation hedge. It does tend to do well in times of crisis and when stocks drop in value; however, the stock market tends to do well over longer periods of time, which should be most people’s investment horizon.
Let’s explore the history of gold, why gold has value, and ways you could invest in gold if you decide it’s right for you.
History of Gold
Gold has a long history. It was widely used as a currency in the past. Currently, it is used in jewelry and electronics, such as computers and cell phones. What I find particularly fascinating is how little is used for industrial applications. According to Statista, only about 7% of global demand in 2019 was for technology. Jewelry accounted for about 48%, investment 29%, and central banks about 15%.
I saw other statistics that gold used in industry is around 10%. In other words, most gold is used in jewelry and for investment purposes. This is important to note because we’ll explore why gold has value later.
In the early 1900s, the US was on a “gold standard”, which meant our currency was based on the value of gold. This worked okay for some time, but World War I and The Great Depression changed it. As the United States needed to print more money for the war, it came difficult to hold enough physical gold to back their currency. By 1933, the United States abandoned the gold standard when people started exchanging dollars for gold and there was a run on the gold reserve.
Starting in 1934, private ownership of gold was not allowed. The government forced people to turn in their gold for dollars. After people turned in their gold for $20.67 per ounce, the government increased the price of gold to $35 per ounce. This increased the assets on the Federal Reserve’s balance sheet because they just received a huge influx of gold and increased the price, allowing them to inflate the money supply. The $35 per ounce price lasted until 1971. It was not until 1974 that people could privately own gold again. From then, the price of an ounce of gold could be determined by the market.
Now that you know more about the price of gold, look at the chart below. It’s easy to see how depending on the time period you pick, gold could be the best investment you ever make or one of the worst. It can go through multiple decades and have no performance. It can also go through short periods of time and have stellar performance.
Over the long-term, it’s been a much worse performer than investing in a diversified basket of stocks. Plus, it has more volatility. Lower returns and more risk. That is not a great combination.
What draws people in are the really good periods of time. You may hit that period of time or you may not. If you are speculating for a short period of time, it may work out. If you are holding it for the long-term, you need to recognize it can go through decades with negative performance, but it can still be a diversifier when times get tough. It does tend to do well when stocks are doing poorly.
Gold has an interesting history, which is probably why there are many beliefs about it.
Why Does Gold Have Value?
Something I have always wondered is why gold has value. After all, most of the use is not for industry. Most is used in jewelry and for investment, which means gold has value because other people believe it has value.
People see it as a safe haven in times of distress. If enough people believe it is a safe haven, people will buy it when stocks go down, which will increase the demand for gold, thereby increasing the price. As long as people keep believing in gold and keep buying it, the value should increase.
Plus, gold does not produce anything. There are no dividends and there is no company behind it growing profits. It’s not like a stock that can produce cash flow or increase in value based on good ideas and products. It really is only what the next person is willing to pay for it.
If people stopped seeing value in gold as an investment or enjoyed it in jewelry, I would speculate gold prices would plummet.
There is also a scarcity element. According to the USGS, about 244,000 metric tons of gold has been discovered to date, which is made up of 187,000 metric tons actually produced and 57,000 metric tons in underground reserves. To put the total amount mined in all of history in perspective, it would fill less than four Olympic-size swimming pools if it was melted down.
People tend to place a greater value on scarce items, which may explain why it has value.
Gold also is very durable. There is a reason people bury it in the background and people find it years later in good shape. You also read stories about gold being found in Egyptian pyramids from thousands of years ago. People can use, reshape, and continue using it over multiple lifetimes.
I see the value in having something as durable as gold. Very few materials match the durability of gold.
How to Invest in Gold
If, after seeing that you can experience poor performance in gold after multiple decades, and you still value it as a diversifier for an investment portfolio or want to speculate, what are the ways you can invest in gold?
There are three main ways to own it:
- Physical
- Options or Futures
- ETFs and Mutual Funds
- Gold Mining Companies
Physical
You can own gold in jewelry, bars, or coins.
They each have their advantages and disadvantages. Some people prefer wearing gold and want exposure to gold through that medium.
Others prefer having bars or coins for more of pure exposure to gold. The difficulty with coins is that people often pay a premium for them, which can be 1-10%, possibly more, above the underlying gold value. Rarer coins can also fetch higher prices, which means you are not purely investing in gold.
The difficulty with owning physical gold is that you need to have a plan for safely storing it. Nothing is perfectly secure, which is why owning physical gold comes with its own problems. You may want to insure your gold, which has a cost. You may also want to pay for a safe deposit box or another method of secure storage.
Also, it is illiquid. If you tried to sell it tomorrow, you likely would have a tough time selling it, unless you wanted to take it to a gold dealer, who likely will pay less than the going rate.
But, people like seeing gold. They like touching it and the tangibility of it. If that’s you, perhaps physical gold makes sense.
Options or Futures
I only mentioned options or futures because you may run across this as a method to buy gold on other websites. I’d personally stay away from options or futures as they are more advanced financial instruments that only people with extensive knowledge and experience should use.
Options and futures are an easy way to make or lose a lot of money in a short amount of time if you don’t know what you are doing, and even sometimes if you do know what you are doing.
ETFs and Mutual Funds
Another way to get exposure to gold is to own a gold ETF, such as SPDR Gold Trust. This is not a recommendation to buy that ETF. I am merely providing an example.
A benefit of an ETF or mutual fund that tracks the price of gold is you can sell it any time, making it more liquid than owning physical gold. Although you don’t physically own gold, you can participate in the performance of gold minus the cost of the fund expense ratio.
Gold Mining Companies
The last method will get you exposure to gold, but it won’t be a very pure exposure. You could own stocks in gold mining companies. Owning an individual gold mining company is risky because if the company does poorly or goes bankrupt, you could lose your entire investment. Even owning a basket of gold mining stocks through an ETF leaves you more exposed to the ups and downs of the market. Instead of just owning gold and being exposed to the risks with gold, you are exposed to the business risks of mining, debt the company takes out, and more.
Summary – Final Thoughts
Gold goes through booms and bust, and with it, booms and bust in the media. In the past few years, gold has been a popular topic because gold has done well again. There will likely be more cycles like we have experienced recently.
The key is to develop a comprehensive investment plan and stick with it. Write everything down and why you own each asset class. If gold fits within your investment plan and investing philosophy, then include it. If it does not fit in your portfolio, try your best to avoid temptation when it does well.
Gold, like any other investment, attracts more attention when it does well and people often jump in at the wrong times.
With gold’s interesting history, I look forward to seeing how people value it 10, 20, and 30 years from now. How much will be for industrial use? Will people continue to use it in jewelry? Will it remain a safe haven during stock market declines?
Time will tell.
In the meantime, remember gold historically has been a lower returning, higher-risk investment compared to other investments. Although that is true, it can be a good diversifier during market declines, but remember, it is very unlikely you will successfully time market declines. If you really want it as a diversifier, you need to remember to be patient during the decades it can perform poorly.
Should you invest in gold? It’s up to you. Hopefully, with this information, you can make a more informed decision.