Does gold make “cents” for you?

By Holt-Smith Advisors’ Staff

There have been a number of people who have asked, “What’s with gold?” Most likely you, too, have read countless headlines on the Internet, in newspapers, and, of course, we’ve all seen the late night infomercials. So why is everyone talking about gold?

There are different roles that gold can play in an investor’s portfolio. Let’s discuss three primary reasons as they relate to the current economic environment: diversification, safe haven from geopolitical risk and a hedge against the U.S. dollar.

Gold makes a strong candidate for diversification as it has little correlation with many asset classes, particularly stocks. For example, the chart below shows the returns for the S&P 500 (red line) versus Gold (blue line) for the last 20 years. Historically, when equity prices increase, the price of gold has decreased. Likewise in a bear market, investors tend to invest more in gold with the theory that gold is a way to “store value”.

 Another reason an investor might allocate a portion of their portfolio to the precious metal is its protective measure against the growing uncertainty of the global economy. Currently the obvious headwinds include the European debt crisis, emerging markets’ battle with inflation resulting from their accelerated growth and the United States’ inability to develop a credible strategy to reduce the deficit and kick start the economy. If politicians and Europe continue to disappoint, gold will likely continue to be a place of safety as demand for “stability” increases.

Finally, gold is a hedge against a weakening U.S. dollar. Gold is considered a universal currency and its value has an inverse relationship to the dollar. In periods when the U.S. dollar has depreciated gold was the beneficiary. We witnessed this inverse relationship during the financial crisis in 2008 when the price of gold actually dropped 20%. Gold was hurt at that time as foreign investors flocked to the U.S. dollar for safety, pushing up the dollar’s value.

With that being said, following the yellow brick road does not guarantee you a safe passage. There are risks involved, including:

1. Gold’s value is not related to its limited functional utility – its uses in industrial applications or jewelry.
2. Gold does not provide any cash flow return. In fact, it “costs” to store it. You buy it, it sits, and you hope that you can sell it at the right time for the right price.
3. Gold is difficult for the average investor to sell because of the constraints of selling a physical asset. The recent introduction of the Gold ETF (Exchange Traded Fund) has helped.
4. Gold prices could be the latest bubble. Its bubble could pop quickly resulting in a fast, steep drop in price.
5. The rocky geopolitical climate may increase gold’s volatility.

Everyone is talking about gold. If you already own gold we would suggest you keep a close eye on Europe. If you do not currently own gold but are considering it, monitoring Washington may be your best signal as to when to purchase.

Disclaimer: This information is provided solely for educational purposes and contains the opinions of the author which are subject to change without notice. It is not, and should not be construed as, an offer, solicitation, recommendation, or endorsement of gold or any particular security, product or service. All information presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Before making any investment decision, prospective investors should seek advice from their financial advisors, take into account their financial needs and circumstances, and carefully consider the risks associated with such investment decisions.