Gold: The pros & cons of investing

Gold is a commodity. It is used in fine jewelry, and some predict the demand for gold will rise in India and China as gold jewelry becomes more popular for an expanding middle class.

But gold is produced primarily to accumulate as a store of value rather than for consumption. So, is it a good investment?

Proponents of gold

Investors give different reasons for investing in gold. Gold generally doesn’t tend to move along with stocks or the dollar. For this reason, some argue that gold can be a hedge against a poorly performing stock market or a weakening dollar.

This tendency to move independently of other markets may reduce overall volatility of a portfolio because when stocks and bonds move in one direction and gold moves in another, the movement of gold will lessen the effect of the stock and bond movements.

Another reason given for investing in gold is that it can be a hedge against inflation. This argument had some support from 1973 to 1980, when inflation was generally over 6 percent in the United States, and the price of gold went up significantly.

Gold proponents argue that gold is a hedge against currency debasement and a safe haven for investors during periods of world turmoil.

Arguments against gold

The argument that gold is a hedge against inflation and currency debasement has been challenged by many.

A study published in the July/August 2013 Financial Analysts Journal concluded after a thorough analysis of data over the past 2,000 years, but particularly since 1974, that gold is a poor inflation hedge for horizons up to 20 years.

The same study argues that gold also is an unreliable currency hedge and should not be relied upon as a safe haven during periods of turmoil and war.

Some analysts say there are inflation hedges that are safer and steadier than gold, such as Treasury inflation-protected securities. Many financial advisers recommend investors keep away from gold.

Warren Buffett, one of the world’s richest people, argues that gold, unlike a business, doesn’t produce anything and its value depends on the hope that others will pay more for it in the future.

The value of gold goes up when people are fearful, Buffett acknowledges, but he believes over the long haul a productive business will yield a greater return.

Buffett’s partner, Charles Munger, has expressed similar sentiments, stating to CNBC that “Civilized people don’t buy gold. They invest in productive businesses.”

Volatility of gold

Gold is very volatile. During the last five years, the price has ranged from $800 per ounce to nearly $1,900 in 2011, to a present trading range in the $1,200s in December 2013. Volatility may affect how much gold you want to own.

Proponents of gold advise investing about 5 percent to 10 percent of your portfolio in gold, although some may recommend more at times for market-specific reasons. If the purpose for investing is to hedge volatility in a portfolio, investing less than 5 percent will reduce the hedging effect.

Because gold is volatile, when it goes up, you may need to sell some to rebalance your portfolio. Remember, the IRS treats gold, silver and other precious metals as collectibles, which don’t qualify for the 15 percent maximum tax rate on long-term capital gains.