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A Closer Look at Gold

By: Rajesh Jyotishi Email By: Rajesh Jyotishi
June 2011
A Closer Look at Gold

America’s got gold fever. Internet headlines inform you that gold settled at another record close today. Nightly news segments show you footage of excited sellers and beaming commodities traders. Radio commercials remind you that gold has outperformed stocks in the last decade. How should you respond to all this?

There’s no doubt that in recent history, the performance of gold is startling. Across the 2000s, gold gained 278.52% on the COMEX while the S&P 500 lost 24.10%. In 2010, the S&P 500 advanced 12.78% and gold notched a 29.76% gain.1,2,3

So given these numbers, why doesn’t everyone put every dollar they have into gold?

Recent price returns don’t tell the whole story. Investing big in gold may seem like a no-brainer – until you take history and inflation into account. In 1980, gold prices were up around $850 an ounce – adjusted for inflation, that’s the equivalent of about $2,300 an ounce today. Yet when 2008 ended, gold prices were at just $870 an ounce. When 2003 started, gold futures were trading at $343 per ounce.4,5,6

Gold is often seen as a hedge against inflation – but from 1980-2002, annualized inflation averaged 3.55% and gold didn’t exactly keep pace. So if you lengthen the window of historical performance, gold hasn’t always trumped stocks.6

Remember, gold is a commodity. Since it tends to have little correlation with stocks and bonds, it can play a significant role in a diversification strategy. On the other hand, gold has no intrinsic value. It doesn’t give you any cash flow. It doesn’t pay you a dividend or earn interest. Gold is only worth what people are willing to pay for it.

Right now, people are willing to pay more than $1,500 an ounce for gold. Three big factors have driven this gold rush - a consistent global demand, an assumption that the dollar will stay weak and a whole lot of speculation.

Bubbles can happen; bubbles have happened. Investors who bought gold at $560 an ounce at the start of 1980 had to wait until 4Q 2010 to break even in inflation-adjusted terms. Those who bought gold at $850 an ounce in 1980 won’t effectively break even until gold prices top $2,300. Gold has performed astonishingly well in recent years – but past performance is no guarantee of future success.2

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