Investing In Gold: What Are The Benefits And Risks?

Last Updated: August 21, 2019
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As a valuable asset, gold becomes more attractive during times of economic uneasiness or political unpredictability. In this article, we've summarized the most important beneifts and risks you should know before investing in gold

You can’t talk of money and finance without mentioning gold at all.  History tells us that it’s been part of mankind’s economic life since its discovery as a precious metal.  As a valuable asset, it becomes more attractive during times of economic uneasiness or political unpredictability.

There’s a long list of investors who have made their riches by just owning gold.  Others who came in late in the game also have horror stories of how the value of their investments took a nosedive along with the prices of gold.

Investing in Gold

It’s quite easy to acquire gold if it’s in the form of jewelry but when it comes to investment, there are just typically three main forms, namely:

  • The gold bars and coins in their metal forms
  • Gold Exchange-traded Funds (ETFs)
  • Shares in gold mining companies or related gold-producing ventures

Hedge funds, institutional investors and short-term traders can also make a gold investment by choosing other vehicles.  They can go via futures contracts, options and/or CFDs.  However, these are all securitized products and carry more risk to investors.

For most investors, the first three choices are most advantageous when they want to buy gold.  Each one of the three has its own upsides and potential downsides as well.

Gold Investing – The Advantages

Since gold is a commodity and doesn’t depend on the economic situation, it has  a couple of great benefits for investors:

Hedge Versus Inflation

Many investors view gold as the answer and protection against inflation.

There are a lot of stories of governments with huge domestic debts (in their own currencies) that try to lessen the value of their money (in comparison to stable standards) so it will be less onerous for them to repay their debts.  You’re probably familiar with QE1, QE2, and QE3 in the US where the Federal Reserve did a quantitative easing by massively buying debts from member banks to maintain liquidity in the economy.  Practically any country experienced a monetary boost during the last decade. Its effect was that people who held on to their cash (as compared to those who had gold or precious art or houses) practically lost out.

Because the government can’t create a natural resource like gold, they cannot reduce its value like what they can do with their own currencies.

History tells us that the amount of gold in the world has roughly risen with economic growth.  It has gone up accordingly with inflation (on average) and kept its (what economists call) “real value” exceedingly well.

To illustrate, note that in the early 1970s, one ounce of gold sold for about $35.  Assume that during that time, you can choose to keep the $35 in cash or get an ounce of gold.  Being of equal value, they would allow you to purchase the same thing, like 30 gallons of milk or a fancy bicycle. Now, if you had an ounce of gold today, it would still allow you to buy a fancy bicycle plus accessories, safety gears, sneakers, and spare tires.  With the $35, you can still buy a kiddie bike or a second-hand bicycle.

What we’re saying is that you would have lost a good amount of wealth if you decided to keep the cash intact.  If you had decided to keep your money in physical gold, you would have multiplied its value by around 33 times.  The value of gold has increased while the value of the dollar has declined during the same period.

Safety

Perhaps the number one reason for gold’s popularity as an investment option is in knowing that the value is going to go up firmly over the years.

Historically, you may see that the price dips once in a while – but it always rebounds.  Looking at the historical chart as the big picture, you can safely predict that gold is going to increase in worth ten or twenty years from now.

In stocks, bonds, or mutual funds, you always have to hope that a specific company or industry is doing well because the value of your investment is largely dependent on their performance.  Not so with gold.  Although the current state of the economy does affect gold prices, a dipping economy does not automatically bring the gold prices down with it.  In fact, it often does the opposite.  When the economy is uncertain, people tend to invest more in gold, and this pushes the price even higher.

Portfolio Diversification

Not many would realize it but investing in gold is an excellent strategy to diversify your portfolio.  We’ve said that the price of gold performs incredibly well even during times of uncertainty.Therefore, a great approach to balance the volatility and returns within your investments is to make gold a part of the roster.

More importantly, with gold being part of a diversified portfolio, you can protect yourself from a “wealth wipeout” in extraordinary situations.  No severe economic depression or a stock market crash will zero out your investments – gold will still be probably standing tall after the smoke clears.

An EFT is one of the best options for gold because it beats having to keep the yellow metal in your vault or secret place.  This way, you only concern yourself with the price and forget about trying to keep it safe from robbers and other adverse physical conditions.

Hedge Against a Disaster

Let’s not kid ourselves.  You invest because you want to make more money and with it comes the natural fear that your investment may somehow end up worthless in the end.  Obviously, that fear becomes less when it comes to gold investing.  For example, if we were to have a repeat of the 2008 stock market crash, you’d be penniless if your portfolio carried only stocks, bonds, and mutual funds.  This is why investors consider gold as a safe haven during times of uncertainty, whether political, financial, or economic.

If an investor invested substantially in physical gold for the long-term, he would probably be sleeping better.  He knows that a financial crisis or global meltdown will not really affect his gold investment negatively.  On the contrary, the price of his gold would normally go up during such trying times because more people turn to physical investment when they see that the financial markets are not giving them a bright hope.

Gold Investing – The Disadvantages

Like any other investment  –  investors should be aware of the main risks of gold investing:

Gold Isn’t A Passive Income Asset

A large number of financial experts, including Warren Buffet, espouse the convention that your investments should be income-generating.  Gold fails this condition because it does not produce anything when you just buy and hold it.

If your objective is to amass a lot of wealth, then it’s better to find an asset that will make you richer.  Warren Buffet began in this direction even as a boy when he bought his first property.  He knew that the value of the land would appreciate but above that, he also saw the potential of earning from the property.

Gold stocks attract growth investors more than they do income investors.  These stocks normally go up and down in synch with the price of gold.  However, you can find well-managed mining companies that are able to turn in a profit even when the price of gold falls.  You will see that the prices of gold stocks tend to magnify the increases in the price of gold.

Gold is Risky Historically

Here’s a fact:  gold and stocks don’t always behave the same way at the same time.  For example, when the stock market is booming, gold is dragging behind.  Since the market has a proven track record of going higher over time, having gold as your sole investment could put you in a risky situation.

Let us show you another deficiency of gold.  Suppose you were back in the 1800s and had a choice to put $10,000 in either gold, bonds, or stocks.  Which of the three do you think would come out ahead?  If you are a savvy investor, gold would fall last on your choices because it performs very poorly in relation to the other two.

Here’s how it will look after 200 years in our present time…

  • The gold will be worth just $26,000.
  • The stocks will have a value of $5,600,000,000.
  • The bonds will command about $8,000,000.

It might shock you but when you look at historical returns, it turns out that gold pales as an investment choice in the long run.

Volatility

Over the years, gold prices have been so volatile that there is a valid reason to doubt its feasibility as a safe haven investment.  The price of gold has to contend with several pressures such as a strong US dollar, shrinking demand from India and China, central banks of other governments and general world peace because gold becomes more popular during periods of crisis.

After peaking in 1980, the price of gold has gone down by 65% in less than two and a half years.  After that, the slow, hard climb took more than 28 years for the price to reach the same 1980 level.  The price of gold breached the $1,800 mark in 2011 but we saw the price plummet to around $1,100 at the turn of 2016.  Currently, it’s doing $1,400 per ounce.

You can see the volatility of this supposedly safe and stable asset class.

The Bottom Line

Every investment has its unique advantages and disadvantages.  If you don’t relish the idea of holding physical gold, investing in shares of mining companies may be your cup of tea.  If you buy into the idea that gold is the best protection against inflation, then you can invest in coins, bullion, or jewelry to lead you to the way of gold-based abundance.

And finally, if your foremost interest is in using leverage profit from appreciating gold prices, the futures market is waiting for you.  Just remember that there is a reasonable amount of risk that accompanies any leverage-based investment.