When Does It Make Sense to Invest in Gold?

Once upon a time, there was a large community of investors who were affectionately termed gold bugs.

These individuals, several of whom prophesied about financial Armageddon, maintained that gold bullion was the only safe harbor in times of inflation and unrest. They stacked gold coins and bars in their bomb shelters and safe deposit boxes and waited for the economy to collapse.

For a while, they did well. In the early 1980s, when inflation was high and the stock market languished, gold prices more than doubled, peaking above $800 an ounce.

But then, for gold bugs, the worst happened. The economy brightened. Inflation and interest rates fell. The stock market heated up. More optimistic investors were making a fortune, and the gold bugs’ stockpiles began to lose their luster--and their value.

Now gold is selling for about $350 an ounce, and despite occasional run-ups, gold prices are expected to languish.

“It has been a long sad road for gold,” said Bruce Kaplan, a dealer in gold coins who has written several books on investing in gold.

“You would have to be a cockeyed optimist to think gold is going to skyrocket in the next six months,” Kaplan said. “Barring some unforeseen disaster, there is no reason for gold to break through the 400 level.”

Month-to-month price statistics provide a graphic illustration of how sorry gold’s journey has been in recent years. The price has occasionally seen brief and sometimes spectacular run-ups caused by political unrest or worries about inflation, but gold’s per-ounce price today is almost the same as in January of 1986.

In other words, if you had invested then, you would have locked up your capital for six years and have no return to show for it.

Worse, there are transaction and holding costs to consider. Those who invest in gold-oriented mutual funds pay annual management fees, and some pay up-front sales charges. Those who buy bullion must pay to store the metal. Conservatively, storage fees would amount to $30 per year per ounce, making the return on the investment negative.

Nonetheless, some still believe that gold can be a good investment. They fall into two camps. One stresses gold’s long-term inflation-hedging properties. The other believes that you can make money by trading gold if you’re clever enough to time the market--buy when the price is low and sell high.

The inflation-hedgers have two arguments. First, they say, over very long periods of time, gold maintains its value. In the time of Henry the VIII, an ounce of gold could buy a man’s suit. Today it still does, Kaplan notes.

Then too it tends to move inversely to stock and bond prices. When inflation is high and interest rates rocket, stocks and bonds can take a drubbing. But that’s when gold starts to shine.

Consequently, investors who want assurance that their entire portfolio is not going to dive at the same time might find that keeping 5% to 10% of a portfolio in gold can make sense.

“When gold is blended with other investments, it helps to balance the portfolio,” said James Hildebrandt, vice president of the World Gold Council in New York.

The problem is that gold generally does not do better than the rate of inflation over long periods. And many investors don’t want their portfolio to simply stand still.

The other camp says the only way to invest in gold is trade it. Here, investors take big risks because gold prices can be volatile over short periods. But they sometimes reap generous rewards.

Traders look for historically low prices. When gold dips below $350 an ounce, most believe that it’s getting cheap. That’s when they consider buying. They sell as quickly as prices allow. If gold prices pop up $20 per ounce two months later, they’re likely to unload. That’s a mere 5.7% profit--not overly generous when considering the risks. But since it was earned in two months, it works out to an annual return of more than 34%.

There are a number of ways to invest in gold. You can buy coins, bars or invest in companies that mine gold. Which strategy is best will depend on whether you’re buying to reduce risk in your portfolio or make short-term trading profits.

Those who want trading profits are more likely to buy stock in gold mining companies or buy mutual funds that invest in mining stocks. The reason: These companies’ shares tend to move more quickly and dramatically than the price of the metal itself.

Those who want an inflation hedge are better off with bullion. Gold coins are recognized legal tender and easily salable through a brokerage or bank, but they cost a little more than bars because the mints charge a premium for making the gold into coins. On the other hand, bars are cheaper, but they usually must be assayed before they’re resold, which takes time and costs money.