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The trouble with investing in gold

April 24, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The price of gold took a precipitous drop in mid-April, dropping by more than $200 in less than a week. With gold prices already down this year, this sudden steepening of their dive gave investors a new wild card to consider.

While many were clamoring to join the rush to the exit from gold, others will view this drop in prices as a buying opportunity. Still others will quietly congratulate themselves for having stayed on the sidelines throughout. Bank rates may not be very exciting right now, but when you see the value of an investment take a double-digit percentage drop in a matter of a few days, it is a reminder that excitement can cut both ways.

This latest development is just the latest twist in a history of gold that is often as enigmatic as it is dramatic. Gold investments are often touted as a type of hedge or safe haven, but prices are so subject to speculation that gold has a history of boom-and-bust cycles.

Gold's boom-and-bust history

The first major run in the price of gold took place from 1970 to 1974. Over those four years, the price of an ounce of gold jumped from $38.90 to $183.77, an increase of 372.42 percent. This was followed by a 27.21 percent decline over the next two years. Then, from 1976 to 1980, gold rose from $133.77 to $594.90, an increase of 344.72 percent. Predictably, this was then followed by a 48.23 percent decline over the subsequent four years.

Then gold did something different. It essentially went sideways from 1984 to 2001, with a series of relatively small increases and decreases more or less cancelling each other out, leaving gold with an overall decline of 10.23 percent to show for that 17-year period. More than that decline, it is having dead money for such an extended period of time that would be most damaging for investors.

After that, gold went on its most spectacular run yet, rising by 601.81 percent from 2001 to 2012. However, 2013 is looking like the year when this party may finally end.

Clearly, gold is capable of some spectacular price rallies at times. On the other hand, if you look at the period from the 1980 price peak to the 2012 peak, gold earned a paltry 3.27 percent annual average over 32 years. What you get out of gold has everything to do with when you get in.

Is this a buying opportunity?

Speaking of which, is this a good time to get in? Price declines will attract some bargain-hunters, but you have to ask yourself a more fundamental question: What role would gold play in your portfolio? It does not produce earnings or pay interest. Your purchase would simply be speculation that people will pay more for it in the future. So, you have to decide whether there is a place in your portfolio that is so speculative.

There is concern that the low level of savings account rates and other sources of income has created asset bubbles, as investors who are desperate for higher returns have plunged into stocks and commodities. The sudden stumble by gold prices illustrates that it is better off to live with low bank rates than to be in the wrong place when a bubble bursts.

Your responses to ‘The trouble with investing in gold’

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susan szoke

12 May 2013 at 9:22 pm

This is true IF you believe the US Dollar will always be the world's reserve currency--doubtful, as many nations now are allying against accepting the US Dollar; you believe the US Dollar, which our stock prices are based on, will not decrease in value despite about 85 million dollars being printed daily on the same amount of gold, which the US gov'mt. suspiciously won't allow to be seen or counted, and won't give Germany it's own gold stored in the US; that inflation won't rise dramatically due to the dollar being worth less every day and interest rates artificially being held down which cannot last in a world market; when world banks of many countries have been accumulating gold at phenomenal rates for years, anticipating a financial crisis worldwide; when our 401k"s, IRA's and gold bullion can be seized by our $16 trillion-indebted government as they were in 1933 by Roosevelt, etc. You are thinking with blinders on, that all will continue as in years before when none of these things were happening. Look at Spain, Greece, the UK etc. and how they tried many of the things we are and it nearly or completely bankrupted them.

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