The Golden Opportunity: A Sound Investment After All

With the recent plunge in gold prices, there is a flurry of articles discussing the nature of the gold bubble, and knocking it and other precious metals as investment options. Specifically, Paul Krugman writes in an article entitled “Gold Does Not Glitter,” published in The New York Times, that the gold crash will finally “bring intellectual capitulation” and that advocates of gold have been greatly misled about the soundness of gold as an investment.

In the Wall Street Journal article, “Gold Sinks into Bear Territory,” author Christian Berthelsen quotes Stephen Klein, a portfolio manager at New York hedge fund AT Global Capital, when he writes that “Gold has always been sentiment-driven, and now the price action shows you that sentiment has changed.” Gold is not sentiment-driven however; it fluctuates inversely with the strength of national currencies such as the dollar and euro. Berthelsen continues, and quotes gold strategist John Paulson of Paulson & Co., when he explains that “Federal governments have been printing money at an unprecedented rate. It is this expectation of paper currency debasement which makes gold an attractive long-term investment for us.” Paulson is right.

What is Going On?

The two main reasons for holding gold – as a currency alternative and inflationary precaution, are sound reasons to maintain gold in your portfolio. In order to understand the validity of this claim we look to the housing market to see how gold fares in comparison to the U.S. dollar. According to the government census page on historical house prices, the median house price in 1975 was roughly $40,000. Using gold’s historical values, let’s say $200 per ounce in 1975, it would take approximately 200 ounces to purchase this house. Right before the 2008 downturn, the median housing price was $240,000 – a six-fold increase in price for what is presumably the same house. At $1000 an ounce, almost the same amount of gold (200 ounces) can buy this same house.

Gold should not be considered in a bubble right before the 2008 downturn, as it is most heavily invested in when the U.S. dollar is doing poorly; the U.S. dollar was obviously the strongest right before the downturn. The 2008 crisis brought with it massive quantitative easing and government bailouts that led to a lack of confidence in national currencies. This in turn fuels speculation for alternatives (precious metals). For this reason, since 2008 gold has seen almost a two-fold increase in its value when it reached its all-time high of $1900 (August 2011).

Companies in the gold industry have been artificially driven up as the government exercises massive quantitative easing as a preventative measure against deeper economic downturns. Producers of gold and ETFs have always experienced steady growth and held its real value against national currencies. Gold should certainly be considered to be a part of one’s long-term portfolio, but never an opportunity to capitalize on speculations due to the uncertainties involved with government policy. What has been happening in the recent days is the correction in gold prices as the economic crisis around the world is steadied, and should not be seen as some final revealing of gold as a bad investment – gold will always be a sound investment.

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