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All that glitters is not gold…..

With so many of the people I talk to concerned about what is happening across Europe and where we will go from here I continue to hear the question “should I buy gold?” And statements such as “the markets are doomed gold is your best bet!”

Now I really get a bee in my bonnet when it comes to statements like this. Very often the main stream media feeds the masses with a lot of sensational nonsense which does nothing for client education and more often than not scares them into irrational decisions.

The draw of gold, which jumped from around $500 per ounce five years ago to more than $1,800 last year, reminded me of some of the past market bubbles of late. The dot com bubble in the late nineties when everyone piled into those stocks driving the price sky high and most of the speculative stocks crashed badly a few years later. Soon after that everybody was jumping into the real estate market and that of course ended pretty badly come 2008.

Most booms and busts have the same pattern. People like to buy things when prices are high. Maybe they think they’ll miss the chance to make a lot of money if they don’t get in like everyone else. What people forget is prices can fall as fast as they rise. They’re investing based on what’s happened in the past instead of what’s ahead.

Many people are fearful that the apparent process of quantitative easing and printing more money will continue to devalue our currencies and they see gold as a secure constant that their investments will be safe in.

Investing primarily in gold could be likened to the great tulip craze in the 17th century where it has been said that at the peak of the market, a person could trade a single tulip for an entire estate, and, at the bottom, one tulip was the price of a common onion. Many believe that much of it was caused through fear and speculation which is abundant at the minute throughout Europe. This type of investment is one that technically does not produce anything but they are purchased in the hope that someone else will pay more for them in the future. It needs an ever increasing pool of buyers who in turn believe the pool will continually increase and expand further.

There are two major stumbling blocks with gold, one is that it is not heavily used in industry unlike copper or aluminium with the actual demand for gold in industry being so limited that it does not soak up new production. Secondly gold itself is not procreative, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

Warren Buffet gives us a nice little analogy to explain gold investment in simple terms and I am going to use it here.

Today all the physical gold in the world amounts to around 170,000 metric tons, if it were melted down it would amount to a cube 68 feet (20.7metres) per side. Using todays price of $1,614 per ounce that would amount to a value of $8,8 trillion and we will call that pile cube A.

Now, let’s  create another pile, B, costing an equal amount. For that, you could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). What do you think an investor with $9.6 trillion would do? Select pile A or pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices (they don’t limit the supply available unlike diamonds, but that’s another article!).

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Most people agree that the time to buy an investment is before its price rises, not after a big run. We don’t know whether gold will pick up again and go even higher than last year but history has shown us that in this type of scenario the risk/reward ratio is not favorable. Most folks would agree that they would rather miss out on the last part of an upward move than get caught in the stampede after a catastrophic decline. Bubbles blown large enough inevitably pop and then the old Spanish proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

If you do decide to go down the gold road you have to decide whether you will buy physical gold or gold shares. Because you can buy gold in many forms, an important question to answer for yourself is what form of gold is best for you.

Owning gold coins or bullion is one choice, but not the only one. Gold in the form of coins or bullion must be stored in a secured environment (not under your mattress). This may involve paying a broker or other firm a storage fee, which can eat into any future profits.

Physically owning gold also has strong emotional appeal – much more so than investing in stocks or futures contracts, for example.

What happens if you need to cash in your gold coin or bullion in a hurry? You shouldn’t have trouble converting your gold to cash, however you will have to take what a dealer will pay.

Gold coins and bullion are often sold at a premium and bought at a discount, so you may not get market price when you need to sell.

Investing in gold securities is not unlike investing in any other security except prices may move contrary to the stock market.

This is not true in each case, especially when investing in gold mining companies. In this case, the price of the stock may reflect the company’s financial health and market position more than the price of gold.

Investing in gold, whether the physical metal or gold-related securities, is a complicated decision and not one to enter lightly.

Most financial experts suggest that you should not have more than 10 percent of your assets in gold with the rest being made up of a broad mix of funds that look at spreading your risk via bonds, absolute return funds, structured products, equity based funds and cash. The exact spread is dependent on your risk profile, present age, years to retirement, future purchases, single/married, dependents and of course your future employment status. This of course is only scraping the top of the iceberg and before you embark on any major investment many more things should be taken into account to ensure it is the right investment for you to follow.


About the Author: Colin MacGregor is a consultant at PIC Europe s.a. in Prague (www.pic-europe.com)