The Ignorant Investor

The price of gold is a big subject on financial blogs and in the press right now, so naturally the stuff has drawn my attention away from my usual practice of spending a day at work thinking about videogames, South Park, and all the actresses I’d like to sleep with.

The story on gold right now has several variations, but overall the view of many bloggers who are sharper than I am seems to be that the metal will continue to increase in value. They say that since 1) inflation is much higher than the official government statistics show and 2) because the wackier and highly stimulative financial policies of our government and central bankers, we’re going to see a widespread loss in confidence in the dollar over the next couple of years. In such circumstances, they say, people will flee to gold as the world financial system shudders under the stress of an American economy cracking, driving the price ever skyward.

Okay. I suppose that could happen. It’s a gloomy scenario, but I’m prone to pessimism and so I’m willing to consider it despite what the Bush Administration tells me about how good my life is. But the next question is, how much gold am I supposed to buy to protect myself from this possible calamity? Even if gold is something I should own, the bloggers don't seem clear on just how what percentage of my money should be devoted to this asset class.

Here's the problem: Gold is inert. It doesn't produce anything. It doesn't grow market share, invent new technology, or provide a much needed service. It doesn't collect rent or make a profit. Its value is based on the desire of people to possess it. That's it.

Now I admit to being conflicted about gold. Ever since it shot up during the economic turmoil of the 1970s, gold's been a big favorite among the speculator crowd and the people who think our economy is headed for a doomsday scenario. And until the past few years gold broke the hearts of these fans. Now it's become the talk of the speculating crowd. It's been the best investment over the past five years, one finance blogger said. The so-called "gold bugs", once mocked for their fanatical beliefs that the metal would shoot upwards in value, seem to be enjoying a renaissance of Florentine dimensions. So naturally, faced with flat indexes, low bond yields, and a cooling of real estate fever- the money is starting to flow into gold funds. Gold mania has begun.

Recently on CNBC, I saw a guy who runs a gold fund say that gold should be in everyone's portfolio (expected given his job) but that gold should never account for a major portion of a portfolio (unexpected, given his job). The problem with pushing gold as huge share of an investor's portfolio is the huge risks involved. If inflation doesn't take off, or if the world's currency market doesn't get all squirrelly, people will start moving out of gold. And there's nothing more subject to the laws of supply and demand than a commodity. A stock might pay you dividends or grow sales even as its market value tanks, but gold doesn't pay anything. Once people start moving out of it, the only way for the price to go back up in real terms is to convince more people to buy it, and as I said before, unless people are worried about inflation or panicking, they generally don't want the stuff. There's a reason why gold was such a miserable investment for decades.

So 10% gold in a portfolio? Sounds like a perfectly sane idea. Some of the macro forces at work in the world seem to favor it. Go as high as 20% if you want to make a bet or can't sleep at night worried about a crashing dollar or financial system. 50%? 100% Hmm, now you're taking some big chances. When times are good and people are feeling confident, gold crashes.

I try and take a broad view here on this blog and generally shy away from predicting the future with any seriousness. I've got a long history of seeing my gloomier predictions gutted by subsequent events, so now I make them only for fun. Who knows what the future will bring?

That's why you have to ask yourself about the next few years: What happens if the economy doesn't shake itself apart? You have to plan not just for the worst case scenario; you also have to make sure you're open to the gains possible in the best case scenario. And if a lot of the economic risks we’re facing right now turn out okay, gold is not the place to be.

So consider gold, but don't be manic about it.