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Investing in Gold: the Pros and Cons

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Cruncher is the pseudonym of an actuary working in London with experience in insurance, pensions and investments.

by colvinha on Flickr

by colvinha on Flickr

Gold. It's cold, hard and in itself doesn't produce anything, but people still make money from it. Just a few years ago investing in gold and gold-related investments was all the rage. But now cryptocurrencies like bitcoin are the flavour of the month. Is it still worth investing in gold?

I can see two possible reasons for investing in gold.

  1. Speculation: trading in and out of the trend to make money.
  2. Protection against a crash. If you, like billionaire Naguib Sawiris believe the market is going to crash, gold can protect your wealth.

1. Speculation

In other words, betting that the price will keep on going up. You are also betting that you will know when to sell your gold to lock in your gains and move on to the next boom asset.

I don't claim to know where the market will go next so I won't give any trading tips (and even if I did they would be out of date before you read this). But if you are interested in short or medium-term trading and trying to beat the market then trading gold is something to consider. Do your research first and make sure you are trading with money you can afford to lose.

2. Insurance Against Inflation or a Market Crash

We can all see the effect of inflation—where the same money doesn't go as far as it used to—in our lives. If you find an old supermarket receipt down the back of the sofa you will be shocked at how much less it used to cost you to do your weekly shop.

Many people see gold as a protection against inflation. But how does that work?

People are worried that governments, who owe a lot of money (in their own currencies) will try to make money worth less (compared to real things) so that it will be easier for them to pay back their debts. That would mean that people holding cash instead of real things like gold or sculptures or houses would lose out.

Because governments can't create gold, there is no way that they can reduce its value directly like they can with their own currencies. Also, in the past, the amount of gold in the world has roughly increased with economic growth so it has gone up in line with inflation (on average) and so kept what economists call it's "real value" pretty well.

I can see the argument that gold can be insurance against very high inflation, and if you have a large portfolio you should consider having a holding in gold. But there are a few reasons I don't personally think gold is suitable for everyone.

Reasons Not to Invest in Gold

1. No income.

In fact, it costs money to store securely. And call me old fashioned, but I like to see my money put to use to grow the economy, allowing companies to invest in new products, not just stacked up in a bank vault. If everyone just bought gold and sat around waiting for it to get more expensive the economy would grind to a halt!

Take a look at this article which explains the difference between investment income and capital gains.

2. It won't always protect you against inflation

It will provide you with protection against very high inflation, or the complete breakdown of the monetary system. It will also provide you with good inflation protection on average. But the key words in that sentence are "on average." There are no guarantees that it will protect you against your increase in costs at a specific time. If you happen to buy when the gold price is high and then it crashes, that doesn't protect you against anything.

3. You can't take it into the shops and spend it

Not yet anyway. So if you keep too much money in gold you may end up having to sell it at a time when the gold price is low and lose money, just because you have to cash it in to pay for your weekly supermarket shop.

4. It's no longer flavour of the month

The more people talk about how well an asset is doing, the more people will invest in it. And for while you can ride that trend and make money—if you don't mind taking the risk. However gold is no longer the hot topic. Instead, cryptocurrencies like Bitcoin are now the market's favourite trend. Now that gold has to survive on fundamentals not just fashion how well will it do?

Spread Your Risk By Buying Other Investments as Well

It is important not to put all your eggs in one investment basket (especially with something so unpredictable as gold) and diversify your investments across different kinds of assets.

For example, why not take a look at the pros and cons of investing in corporate bonds and of investing in stocks and shares, or for something a little different, in preference shares.

This is a medieval treasure trove found at Fishpool in England. One thing gold has done is remain valuable over long periods.

This is a medieval treasure trove found at Fishpool in England. One thing gold has done is remain valuable over long periods.

Conclusion

In my opinion, investing in gold is only suitable for the wealthy who need to have protection against extreme inflation and for those who are happy to take large risks in trading the market in the hope of large rewards.

You should always think carefully about your investments. Nothing on this page is financial advice. You may want to take advice from a professional before investing. Investing always carries risks, including the risk of missing out on other investment opportunities.

I personally think most ordinary investors are better off considering more traditional assets such as corporate bonds or stocks and shares, but whatever you do, good luck and happy investing.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2012 Cruncher

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