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Fool's Gold or Real Deal?

Fool’s Gold or Real Deal?
Ron DeLegge
October 29, 2010

SAN DIEGO ( - People are jumping on the gold bandwagon just like they jumped on the dotcom bandwagon and the real estate bandwagon and every other bandwagon before them.  Is this time different?

Never mind gold’s 20 percent plus rise this year, it still has a lot of overlooked weaknesses as an asset class. Goldbugs won’t like this, but here’s just a few:

Strike 1: Produces No Income
What’s among America’s top financial problems? New findings from the Center for Retirement Research at Boston College give us a clue.

CRR research shows a massive $6.6 trillion shortfall in retirement income. Contributing to this colossal problem are bank savings accounts, CDs, money market funds, corporate and government bonds (NYSEArca: AGG) all yielding a lot less than before because of rock bottom interest rates. Simply put, Americans are strapped for income.

What about gold?

Unfortunately, investing in gold won’t help the average working or retired person to fix their retirement income deficit. Why? That’s because a major drawback of gold is that it produces no income. And that’s bad news especially if you buy gold at the wrong price and it ends up going down or going nowhere.

Should people with an inadequate income stream or an income problem be betting the house on gold? The answer is absolutely not. And even individuals with sufficient retirement income should probably do a double take before overstuffing their investment portfolios with gold. 

Strike 2: Long Periods of Underperformance
Proponents of gold investing are quick to remind curious onlookers that gold has never been worth zero. And while this is an interesting argument it conveniently omits a few things.

First, just because gold has never been worth zero doesn’t mean it’s always been a good investment. In fact, there have been many long periods of time when gold’s performance was nothing short of awful. Are our memories that bad that we’ve already forgotten them? Let me help you remember. 

After reaching a record high of $850 per ounce in January 1980, gold prices fell over 40% in two months. And even then, the worst wasn’t over. It took gold 28 years to reclaim the $850 level. Will we see a repeat incident of gold’s historical head fake?

Today, the fact that gold has become such a popular trade should raise some red flags. The crowd is rarely right and if they are it’s usually short lived.

Strike 3: High Ownership Cost
Another overlooked facet of gold investing is the high ownership cost. If you’re considering making an investment in physical gold, don’t dismiss or ignore these significant expenses. 

Acquiring physical gold in the form of coins or jewelry involves paying high transaction costs, commissions and possibly even sales tax. And then there’s the additional cost of insuring the gold and storing it in a safe location. All of these things reduce the gold investor’s return. Is the presumed “safety” of gold really worth all of these very real and very high costs?

Strike 4: Unfriendly Tax Treatment
Strike four against gold is its unfriendly tax treatment.

All gold and precious metals investments, including gold ETFs (NYSEArca: GLD) and silver ETFs (NYSEArca: SLV) that take physical delivery are taxed by the Internal Revenue Service as collectibles, which is subject to a higher long-term capital gain rate of 28 percent versus securities. Under current tax law, most tax payers will pay a maximum long-term capital gain rate of either 5 or 15 percent depending on their income tax bracket.

For this reason, some investors are opting for gold securities like miners (NYSEArca: XME), small cap miners (NYSEArca: GDXJ) or countries with heavy exposure to the mining sector like South Africa (NYSEArca: EZA).

Incidentally, this year’s zero percent tax rate on long-term capital gains for individuals in the 10 percent or 15 percent marginal tax bracket applies to securities but does not apply to collectibles like gold or silver.

What and Who's Problems is Gold Solving Again?
For the record, I’m not an anti-gold person. I happen to like it a lot, especially the way it looks on my wife.

However, gold fails to attack the crux of America’s financial problems. As mentioned earlier, inadequate income is a $6.6 trillion dollar problem for working people between ages 32-64. And as an asset that produces zero income gold is the wrong answer for America’s income problems. (On the other hand, overheated gold sales definitely solves the income problem for gold hawkers, jewelry stores and coin dealers.)

This is not to say that gold does not deserve a place inside a diversified investment portfolio. It does. However, its place probably shouldn’t be as large as some investors are making it.  

CommentsAdd Comment

ETFstrategyLove said on October 31, 2010
There has been wealth cycle every 30-40 years. Now it's the time again.
We had Gold bear market starting from 1980-2000. Ever since 2000 the Gold has been rising and broke 850 all time high and we are at 1350 now.
Compare to year 1980 this market has a lot more potential to go higher.
Driving force in 1980 was only United States and Western Europe that's only 10% population. Now everyone in the planet can buy Gold and silver this time. That is A HUGE difference. If you know the history of money you know that this bull market of Gold price will be in the HISTORY because we will see the biggest bubble in the history.
We are also seeing the Shortage of both Gold and Silver. but especially silver.
I believe once we hit gold 2000-3000 a lot of smart people will move to silver market.
Ron said on October 31, 2010
  Hi John,

Your arguments aren't very convincing either.

1) You don't care that gold produces zero income forever?! You will care when gold prices fall below what you paid for yours. It's at that point we all start to squirm for ways to make some $$ while we play the waiting game.

2) Congratulations you still remember the stupidity of putting all your money in an S&P 500 index fund. Now what about gold? Actually, you make a great case for diversifying. Was that by accident or on purpose?

3. FYI, You can own stock and bond ETFs for less than the 0.16% you're paying to store your gold. (See Charles Schwab or Vanguard ETFs)

4) Too bad you can't hedge your physically stored gold against falling prices. At least with gold ETFs like IAU or GLD you can buy some insurance protection with put options.

5) Smart asset location (not allocation, LOCATION) will help you to reduce your tax liabilities associated with owning gold. Then again, the typical goldbug is too dumb to know the difference. Here's to hoping your not one of them.
John B said on October 30, 2010
  You have made some questionable points. I think overall the greater weaknesses are in your arguments.

1. As you said, owning gold does not produce income. Well neither do many stocks (neither do CDs, savings accounts, or money-funds, or short-term treasury bills for that matter). This is not a weakness limited to gold, and it's not really a weakness -- it's just part of a financial plan.

2. You say, "After reaching a record high of $850 per ounce in January 1980, gold prices fell over 40% in two months. And even then, the worst wasn't over. It took gold 28 years to reclaim the $850 level."

I say, ""After reaching a record high of 1553 in March 2000, the S&P 500 fell 50% over two years. And even then, the worst wasn't over. In 2007, a second bubble popped with the S&P experiencing a second plunge of 50%. Now, after more than 10 years, the S&P 500 is still 25% below the 1553 level."

3. I put my gold in a safe deposit box in a bank. It costs me about 0.16% per year. The cheapest mutual funds cost you more: 0.2% per year, and the average mutual fund costs you much more: 1.5% per year. Gold is very cheap to own.

4. There is a tax disadvantage to owning gold. You got me there. On the other hand, I prefer paying a higher tax on profits from gold than losing money on bonds due to higher interest rates and inflation in the future.
Bill Dakelski said on October 29, 2010
  Perhaps the only puropse of gold in a portofolio is as a hedge against global hyperinflation. It serves that nitch well. Ten to fifteen percent should do it. Just don't expect to receive any additional return. Basically it an insurance policy. The great thing is you can always cash it in and you might even get back more than you paid. You can't have your cake and eat it too.
gold digger said on October 29, 2010
  I like gold.
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