Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two than they are now. And if they become more afraid you make money; if they become less afraid, you lose money, but the gold itself doesn’t produce anything.
Sage Advice on Gold
As celebrated investor Warren Buffett suggests, gold is sometimes used as the “crisis commodity.” When people are anxious or frightened and times get tough–either financially (as in the wake of the 2008 crash) or geopolitically (as perhaps now, following U.S. strikes against Syria and threats from North Korea), they often turn toward gold in the hopes it will provide a safety net.
As such, it is no surprise that clients often ask me if they should own gold. My reaction is to ask what purpose they want it to serve. A purchase of gold, after all, is not an investment; it is speculation. And it does not align with the principles of prosperity economics. And yet, it still has its allure.
For one thing, gold has a long history of worth. An ounce of gold, it is said, could buy a high-quality man’s suit a few centuries ago, and while the nominal (or face) value has skyrocketed since then, it has held its value in terms of that suit. In other words, an ounce of gold still buys a high-quality man’s suit. In this respect, gold has been a good hedge against inflation–over a very long period of time.
Whether that will continue, of course, we can’t say. We do need to remember, though, that there were some uncomfortable bumps along the way.
In 1933, president Franklin D. Roosevelt, in an effort to mitigate hoarding and international speculation during the Great Depression, ordered citizens to turn over most of their privately held gold coins to the U.S. government in exchange for $20.67 per troy ounce ($382.00 in today’s dollars, based on a CPI estimate by the Federal Reserve Bank of Minneapolis.) Individuals were allowed to own up to 5 troy ounces worth $100, or $6339 in 2016 dollars. Then, the following year, the government nearly doubled the price of gold for international transactions to $35 per troy ounce ($648 in today’s dollars.)
The price of gold remained stable for nearly 40 years–until president Richard Nixon in l971 eliminated the gold standard, meaning gold no longer backed the U.S. dollar, even for the purposes of international exchange. Three years later, president Gerald Ford repealed FDR’s limitation on ownership of gold by U.S. citizens.
More recently, we have seen gold lose significant value during the stock market recovery following the financial crisis. In August and September of 2011, the price of gold went as high as $1,900 an ounce. Then it steadily tumbled until it traded at just below $1050 an ounce in December of 2015, representing a 45% loss and a six-year low. As we write this article, gold sits at $1242 an ounce, the same price it sold for in 2010 on its way up.
Although I personally find this history unsettling, there is no question that some people sleep better at night knowing there are gold coins in the family safe. If this is you, go for it– but in moderation. Stick to gold coins of known weight, since coins would be the most tradable or sellable form of gold.
As a general rule, stay away from collectible rare coins, which, as works of art, have value beyond the metal. Selling these “numismatic” coins, as they are called, requires significant sophistication and is not for amateurs. You’ll also want to pay attention to potential capital gains, the rate can be higher for collectibles, up to 28%, and that applies to holding any physical gold, not just numismatic coins.
Investing Vs. Speculating
But let’s face it: Gold is not an investment, so let’s not treat it as such. What is an investment–as opposed to speculation? Speculation involves risk and requires you to make a correct prediction as to the future price of an investment. We define a good investment as an asset that will grow and/or produce cash flow with no loss of principle.
Furthermore, as my colleague No BS Money Guy Todd Strobel points out, investments should solve a problem or enhances peoples’ lives. We’re not huge fans of the stock market or bond market, but at least with a stock or bond, you are investing in a company that is performing a service. With gold, you’re left with a guessing game.
Gold, of course, can provide some tangible benefits. It is used to craft fine jewelry and in the circuit boards of mobile phones, due to its ability to conduct electricity even better than copper. It has been used to fill cavities. But honestly, it serves no purpose in its incarnation as a coin in the family safe or as a gold bar sitting in a vault. We get a kick out of Warren Buffett’s pithy remark on the subject:
Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
In my practice, I urge clients to position their savings and investments to serve one of three goals: 1) to create an income stream; 2) to be liquid and available as an emergency/opportunity fund; or 3) to grow their money for use at a later time, preferably steadily and without the need for speculation. Gold, unfortunately, fits none of these categories well. Let’s examine these 3 functions further:
Gold Vs. Cash Flow
To begin with, I advise my clients to focus on cash flow–not net worth. That’s because net worth does not pay bills; cash flow does. Even if you accumulate $1 million in savings or CDs paying only 1%, you’ll only be able to use $10,000 per year sustainably.
The aim of gold in a portfolio, on the other hand, is usually to increase or protect net worth, not cash flow. In fact, if you buy gold, you have decreased your cash flow because your gold coins are sitting in a safe (or vault) rather than being put to work for you through an investment that creates cash flow such as rental property, a peer lending portfolio, or commercial mortgage bridge loans.
Gold is not an ideal place to invest for liquidity for emergency/opportunity funds either. Most prospective buyers find out the hard way that it’s much easier to buy gold than to sell it, unless you are willing to take a large loss. And this can be true whether you are buying and selling “rare gold coins”, Kruggerands, American Eagles, or heirloom jewelry. If you sell gold to a jeweler, for example, you can expect a haircut ranging from 20% to 50% from the spot market value of the underlying gold.
That said, a new opportunity has emerged in the last few years that allows people to buy (or sell) bullion, have access to it, and have it delivered to their home or a vault outside the banking system. For those who wish to include gold in their portfolio, Gold Bullion International (www.bullioninternational.com) is an Internet platform that allows financial advisors to input an order, which goes up for bid among 12 dealers and refiners. Clients can store their gold at home or in vaults in New York City, Salt Lake City, London, Zurich, Melbourne, or Singapore. Fees, which cover the dealer network and the transport of metal from dealer to vault, range from .25% to 1.8% of the value. Storage fees, including insurance and audit, range from .25% to .6%. Settlement is two days.
Admittedly, this looks pretty liquid–for speculative purposes anyway, where you are betting you can buy low and sell high and can afford to take your time doing it. Most of us are not good at that, though; I’m certainly not. And while there can be a place in peoples’ portfolios for speculation, investors must be clear that’s what it is, and in the case of gold, they should bear in mind that prices can be volatile. “If you cannot handle 25% swings in gold prices,” as one Barron’s reader admonished, “gold is not for you.”
Gold for Emergencies and Opportunities
In fact, gold’s volatility may be at the heart of why it does not serve as an appropriate vehicle for an emergency fund. Add to that Bullion International’s seemingly small fees, which are still meaningful if a family needs liquidity for, say, groceries. If you are looking to physical assets to serve this purpose, I much prefer gardens, water or food storage–items that are useable, helpful and tradable.
And let us not forget the U.S. dollar either. At present, it is still respected and accepted, and it still remains the world’s primary reserve currency. According to Wikinvest, 25 different currencies are pegged to the U.S. dollar, and 85% of all currency transactions across the world involve the U.S. dollar.
In terms of price stability and ease of use and trade, the dollar has actually been more stable price-wise than gold and is certainly more usable than gold coins in the present economy. And if bank crises in India, Cypress and Greece are any indication, having extra cash on hand can come in very handy.
Gold for Growth
Of course, many people also invest in order to grow their money. Clearly, gold is not the best place for this, if for no other reason, there is such a high risk of loss of principal. Many people who purchased gold following the Financial Crisis are still holding it, waiting years in the hopes of simply breaking even.
When you invest in gold, you have no control of your asset–something that is a big deal with us. Our 7 Principles of Prosperity™ teach our clients to keep their dollars under their control so they can make choices about their money instead of having someone else –or an unpredictable market–make choices for them.
Does Gold Belong in Your Portfolio?
Only you can decide! We’re not big fans of gold because we want our clients to obtain predictably positive results with their investments. Because gold detracts from cash flow, costs to store and liquidate, and does not grow in value reliably, we’re going to side with the Sage of Omaha on this one.
We’ll also side with the Sage on our favorite alternative investment for long-term growth; it’s an asset class that Warren Buffet has put many millions into. This little-known asset does not roller coaster ride with the stock market, nor is it sensitive to political events, interest rates, or real estate values. And yet, it can produce growth of high single digits, even low double digits.
If you would like more information about this alternative investment for growth or the alternatives we recommend for cash flow and liquidity, we invite you to download a complimentary copy of Financial Planning Has Failed. This ebook outlines the problem with typical financial solutions and describes the Prosperity Economics solution that helps investors grow sustainable wealth… without Wall Street risks or speculation.
And of course, you’re always welcome to simply reach out to us with your questions or for more information.