Street Smart: Understanding Wall Street: The Golden Rule

Ian Ogilvie: Examining the most popular claims of proponents of gold as an investment choice.
By Ian Ogilvie Modified: April 22, 2013 at 11:02 am •  Published: April 21, 2013
Advertisement
;

We know that gold has become far more popular as an investment in recent years. Exchange-traded funds that track gold have proliferated in the last 10 years or so, which has made it easier to invest in gold. According to recent filings with the SEC, the SPDR Gold Shares Trust, one of the best-known gold ETFs, had more than 1,100 institutional holders, not to mention individual holders. According to the World Gold Council, an industry group, gold demand coming from investments (including both physical gold and ETFs) was 16 percent of total demand for gold in 2004 (the first year ETF numbers are available), but almost 35 percent of total demand in 2012. Gold's wide ownership means that it may not provide the benefits of diversification that one might expect.

Fear of political and economic instability does lead to buying of gold, and may explain some of the run up in price since 2008. Many companies that deal in gold as an investment point to hard times in their sales pitch. Some even advertise on syndicated talk radio shows and scandal type TV shows, both breeding grounds for pessimism regardless of their political posture. At this extreme, gold has an almost survivalist appeal.

Warren Buffett has been famously critical of this aspect of gold's appeal, stating that gold purchasers depend on the notion that “the ranks of the fearful will grow” creating a self-fulfilling prophecy that increases the price of gold — for a while. Buffet himself prefers to own what he calls productive assets, such as farmland and companies that pay dividends. Gold is better for fondling, as he puts it.

Supply and demand

What about the supply and demand argument? Proponents of gold as an investment point out that the supply of gold is limited while demand for the metal has grown. This is accurate: annual gold production has increased little even as the price of gold has gone higher during the last decade.

But supply and demand is a tricky pitch by itself because, like the fear trade, it also works until it doesn't — “for a while,” as Buffet says. If the demand side of the equation dries up, for whatever reason, the price of gold is apt to go lower. Economic growth in China or India might slow down, Cyprus and other governments might have to sell gold reserves, the U.S. economy may improve, other assets may become more attractive, expectations of inflation may recede. Take your pick.

Many smart investors buy gold. But gold should be viewed as just another investment option. Recent events show it is not the “safest” asset class, as some might proclaim, even if there are legitimate reasons to own it. As with any investment, claims made by people selling gold should be researched — and met with a healthy dose of skepticism.