Market Beat: Pay attention to gold and inflation
March 10, 2014
Gold and other metals can be very good diversifiers for a traditional stock and bond portfolio. Gold is also an inflation hedge. Over long periods of time, the price of gold will increase with global inflation, with much more volatility in the short term.
Gold is highly leveraged; each bar of gold in existence is hypothecated roughly 70 times for trading in the markets in the form of futures and options.
This leverage can make the price of gold quite volatile in short time frames. Since 1975, when President Nixon took us off of the gold standard, investors have been able to own gold. Before that, it was a federal offense to own gold except in the form of jewelry.
Gold performed very well from 1975 to 1981 when it peaked out at more than $800 per ounce. From 1981 to 2001, gold dropped down to $250 per ounce over a 20-year period.
The next 10 years, gold performed very well as it rose to more than $1,900 per ounce on Aug. 22, 2011; since then it has dropped to just more than $1,300 per ounce today.
Since 1975, when it became legal to own gold, a savings account earning the Fed funds rate would have outperformed gold by a little more than double.
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By studying the history of gold prices since it began trading on the free market in 1975, it becomes apparent it is important to have a way to value the price of gold relative to something. By correlating it to inflation we can do that.
Investors today have many choices if they want to add some gold or other precious metals to their portfolio. There are several ETFs that represent gold, silver and platinum. There are ETFs that own the physical gold and do not depend on owning futures or options contracts.
Gold mining stocks can represent some real values. Many of the mining companies have known reserves that are quite substantial. If you look at the supply demand equation for physical gold, today you'll find that the demand is quite strong.
When the price of gold fell from the peak in 2011, the price of mining shares dropped dramatically, too creating some attractive multiples.
By including gold and precious metals in their portfolio, investors can achieve a higher level of diversification than they can get from a stock and bond portfolio, but it is very important to pay attention to where the price of gold is relative to inflation when purchasing it.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at http://www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.