The slip in gold prices certainly runs counter to the widespread and reasonable notion that gold is the ultimate hedge. The reasons behind the slippage are troubling.
First, gold has formed as large a bubble as real estate did a few years ago. We don’t have to repeat where the real estate bubble went! But here is a worrisome similarity: both bubbles looked surefire. Real estate drew in the wise investor and the neophyte. After all, more people were buying homes; credit was easy; and, of course, the falling dollar caused many to scurry for a “safe” investment. A few years later, gold also looked safe in the midst of falling corporate profits, the collapse of real estate and the never-ending slide of the dollar. But all bubbles are prone to burst. (Modest increases such as those in stock market history are more likely to remain.)
Gold bears other fearsome traits that real estate does not. Gold is not especially useful. Around New York City, one finds old-fashioned sandwich boards advertising good prices for used jewelry. Jewelers can’t wait for the price of gold to fall so they can use new gold. In addition, there is no “gold standard.” Those who buy and sell gold agree it is valuable but it is not equal to or used to back up currency as it once was.
After a market declines, it is likely to return. Real estate will eventually right itself through supply and demand. People need homes; they do not need gold.
Another annoying feature of gold as an investment is that it does not produce its own dividends. When a bond matures or when a company declares a dividend, the owner gains income. Gold does not reproduce. You hope the price per ounce will rise. Like works of art, the gold you buy remains the same. But unlike art, the long-term intrinsic value of gold does not rise. It only remains attractive as a hedge.
While the 2011 stock market reveals a good deal of volatility, and the euro-zone sends shivers across the investment world, everyone is not shifting to gold, as the TV ads would have us believe. US Treasuries and the US dollar are faring well partly as a reaction to trouble in Europe. Corporate stocks should rebound because despite the doom and gloom over the economy, corporate profits are returning. Even junk bonds are making a decent run accompanied by falling default rates, which lowers risk.
So, if you hold a massive portfolio of gold, this might be a good time to adjust. If the gold bubble bursts, there may not be any champagne bubbles to go around. Like a few Hollywood starlets, gold’s beauty may not sustain long-term success.
Stay tuned – another myth will be “busted” next month. Please comment on this myth and let us know which myths need exposure.
Michael McTague, Ph.D. is Senior Vice President at Able Global Partners, a financial consulting firm in New York City.