There are some very good reasons why you should own gold. In particular, gold is a financial hedge, a safe haven, it can grow in value, and it is a great way to diversify a portfolio. Consequently, a strong case can be made that gold should be foundational to those pursuing financial success.
In this article:
- What led me to gold were the things I learned during a market bubble
- Reasons Why You Should Own Gold:
- What naysayers say about gold
- When and how to buy gold
- How much gold should you own
- Storing Gold
- Investing in silver
What led me to gold were the things I learned during a market bubble
Euphoria and Greed
I remember one particular day, in which I was sitting in front of a computer, while the TV behind me was on a business channel. It was holiday or a day before a holiday, and the stock market was open for trading for half a day. This was yet another day in which TV hosts were euphoric about the stock market. I was looking up a small company and was thinking that this company’s stock would also skyrocket if they only entered the online market. Imagine my surprise when I heard someone on TV announce exactly that!
Indeed, the exact stock I was just looking up was about to skyrocket. Of course, I didn’t want to miss out on this opportunity. So, I sold some shares of one of my mutual funds and bought a few shares of this particular stock. This was right at the time when the stock market was about to close. The stock price was already going up, so I placed an order at market value, whatever the market value was.
It seemed everyone else had the same idea, because when the transaction settled I noticed the price I paid was almost double what it was when I was tracking the stock. Oh well, I was still excited because clearly this was a hot pick.
My plan was to sell quickly because I didn’t want to get caught in a bubble! After all, I was somewhat aware that the predominant sentiment driving this euphoria was greed. Besides, everyone knew the stock market could not continue to climb up like it had been. But even so, greed was so strong that it overcame common sense. These sentiments should have been a warning.
A Lesson on Valuation
When I checked the stock price the next trading day, I was shocked to learn that this particular stock had opened at about half of what I paid.
Have you ever wondered who the sucker is that buys at the 52 week high? Well, that was me on that stock.
What a lesson! I told myself I should have placed my stock order at a ‘limit price’ rather than at the ‘market price’. Haha! I still hadn’t learned that the real problem was that I was completely ignoring the fundamentals behind the company.
Like everybody else, I was gambling that the stock price would go up because the company had announced an internet presence. In retrospect, I am glad this happened back then. It was best to learn this lesson when I could only invest $1,000 than when I could invest $10,000 or more.
Remember my boss? The one that spoke of retiring early if Level 3 hit $100? Apparently he held on to the stock, because he didn’t retire. I don’t know how long he held onto it, but by September of 2000, that stock was trading below $50. And by 2001 that stock was trading below $5. Ouch!
Greed is a hard thing to overcome when the stock market is hot. Nevertheless, experiences like these teach us priceless lessons.
Eventually I began to re-focus on valuations, something I already knew about, but had chosen to ignore. After all, valuation is the most important thing to understand in any investment type.
On the subject of valuation, I intend to devote a significant effort in discussing this in greater depth and hope to interact with readers about this. In fact, I recently launched a forum section in this website for the purpose of discussing valuations.
The importance of contrarian thinking
In addition to refocusing on the fundamentals, I began to pay more attention to the emotional side of stock investing. That’s when I began to look into gold, silver, and contrarian investing.
Despite my dot com story, I’ve always been a bit of a contrarian – not necessarily a good personal quality, just ask my wife. However, when it comes to investing, perhaps it helps to consider contrarian sentiments.
One contrarian investor, and speculator, whose work I have studied is Adam Hamilton. He is the brains behind the website Zealllc.com. If you study his work you’ll begin to understand the ebbs and flows of the markets and their correlations to fear and greed. Obviously, he is a big believer in gold and silver investing.
Through studying his work, I’ve learned to be mindful that when the markets go up, people get greedy, which further feeds the markets to the point where they become unsustainable, eventually causing the markets to go down.
And when the markets go down people become fearful, which further feeds negative sentiment into the market to the point that bargains start to emerge, causing the markets to go up, and then the cycle repeats.
That’s what happens during a normal market cycle. However, monetary policies can artificially alter these cycles, to the point where stock valuations take a backseat. If fundamental principles such as valuations behind a stock are no longer the driving force behind stock prices, then how can an investor know what to invest in?
Reasons Why You Should Own Gold:
Gold as a Hedge Against Inflation
One of the most common reasons cited for owning gold is that gold can function as a hedge against inflation.
Everyone knows that inflation causes the dollar, and all other paper currencies, to lose value over time. This is because governments can print more money, whenever they chose to. Thus, paper money has no real value, other than what we all agree to give it.
Gold on the other hand retains its value, as no government or entity can create more of it. The closest thing to creating gold is mining. And mining gold is difficult and expensive, because it is very rare.
Here is a good illustration of the dynamic between the US dollar and gold. I recall reading that back in the 1900s a person could buy a tailor-made suit with $20 bill or a $20 gold coin. Today a $20 bill will probably get you some nice socks, but that same gold coin will still buy you a nice tailor-made suit.
Hedge Against Deflation
What is deflation? According to Investopedia, deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. During deflation, the purchasing power of currency rises over time.
In today’s environment many believe we the US and perhaps the world is on the verge of deflation. Many others believe inflation is more likely. This is a bit of a difficult subject to understand. What I believe is fascinating is that most of these experts agree either deflation or inflation is good for gold prices. In fact, most of the discussions I’ve come across on this subject come from the gold-bugs. See Will monetary ‘shock and awe’ send inflation soaring or are we set for deflation? Either way, gold looks like a safe-haven bet for investors…
Gold as a Safe Haven – Geopolitical Risk
Gold is also a form of insurance. It may be hard to imagine in our current climate, but any of the markets (the currencies market, the stock market, the housing market, etc) could crash at any time. When this happens, gold will at a minimum retain its value, and in most cases will rise in price.
Have you ever wondered what exactly gives the dollar its value? I don’t know that anyone can really answer that, and logically justify its valuation. After all it’s all just paper money.
During the six years that followed the great market crash of 1929, the US Dollar was losing value, yet Homestake Mining’s stock soared more than 500%! This company’s stock performance is considered to be representative of the gold market back then.
Consider more recent examples in countries like Argentina, Greece, and Venezuela, where their currencies collapsed and became worthless. That’s an extremely scary situation for most, but those holding gold, in a situation like that, have nothing to fear.
Indeed, think of what an incredible position you would be in if everything around you is losing value and you own the only asset that actually soared in value. Contrarians love situations like this, because huge opportunities arise when fear dominates the markets.
Gold’s safe haven quality also applies globally. It isn’t hard to identify the correlation between geopolitical events and gold’s price. Suffice to say that whenever geopolitical risks arise demand for gold increases.
Gold as Currency
Gold has been used as currency throughout history. Despite what naysayers may say, gold is likely to always have value as currency. In addition, unlike many other investments, gold is a fairly liquid asset. If you have a gold coin in your hand chances are you’ll be able to trade it for something of significant value. On the other hand, if you have a stock certificate in your possession chances are you won’t be able to trade it for anything.
Gold as Diversification
Another reason to own gold is portfolio diversification. When people talk about diversification they are mostly thinking of diversification within the stock market. Most investors forget about gold when stocks are flying.
Back when I was investing heavily in the stock market, I continuously made the mistake of not diversifying my portfolio. Specifically, I was heavily invested in technology stocks. It wasn’t until I lost money during market downturns that I was reminded of the importance of diversification, but even then I wasn’t diversifying into gold.
Gold’s Potential for Growth
Gold can also be an investment that grows in value due to its limited supply and increasing demand. As mentioned earlier, gold is a scarce resource, because it is hard to find and expensive to mine. But also, gold’s demand is likely to continue to increase due to its vast industrial applications and for all the reasons discussed above.
In my case, I bought my first ounce of gold for about $350, in 2005. Today gold is trading at $1,552. And many financial analysts are anticipating much higher prices in the coming years. Eventually, more and more investors will realize gold’s potential for growth, which could also lead to euphoria in the gold market and much higher gold prices.
Gold as a Foundation for Financial Success
Admittedly, I wouldn’t recommend making gold your main investment strategy, but rather I recommend making gold a part of your overall strategy. In the introduction to this article, I indicated there are some very good reasons why you should consider owning gold and noted that a strong case can be made that gold should be foundational to those pursuing financial success.
Keen investors may recall an article titled ‘The Bridge to Financial Freedom,’ in which I outlined the three main areas of such bridge. In short, these are the foundation, the substructure and the superstructure. I won’t dive into this here, but in this analogy gold is part of the foundation of the bridge. In other words, gold is a component of a larger strategy, and not the main strategy.
The overall strategy behind the bridge to financial freedom is to invest in multiple cash producing assets. Thus, an investor needs a certain amount of capital, which comes from savings. And said capital must be protected from inflation until we are ready to invest it. This is where gold comes into play.
What Naysayers Say About Gold
In preparing for this article I wanted to look into what naysayers say about gold. One such person is Dave Ramsey, a well known financial personality. In one segment he stated that “gold is highly volatile, highly speculative, <a> bad track record investment.”
I have a high respect for Dave, but I disagree with him on a few things, and this is one of them. His comment is very interesting, as it appears he is using the US dollar as a baseline. In such case, the US dollar maintains its value, while gold experiences volatility.
This logic is like playing the kids’ game ‘opposite day’. In reality, it is much more likely that gold is maintaining its value while the US dollar is experiencing volatility. As mentioned earlier, the US dollar has nothing of real value backing it. Gold on the other hand has real value and no person or government can change that.
I also came across a video from The Motley Fool titled ‘Why Investing in Gold isn’t a Good Idea.’
Interestingly, this naysayer concludes with, “If you are worried about an economic downturn, it may make sense to have a small portion of your portfolio in gold, but it certainly shouldn’t be your main investment strategy”. There you have it. Even a video dedicated to why you shouldn’t invest in gold concludes that it may make sense.
When and How to Buy Gold
Despite all of the above, at times it can be argued that gold is in overbought territory. If you decide to add gold to your portfolio, be careful not to chase the price. Thus you may consider investing via the dollar cost averaging strategy, by buying in predetermined amounts over several months.
Below is a chart from Kitco.com showing the spot price for gold, silver, platinum, and palladium. The chart shows the current bid price, the change in price, the high, and the low for the day.
![[Most Recent Quotes from www.kitco.com]](https://i0.wp.com/www.kitconet.com/images/sp_en_6.gif?w=1170)
Buying Physical Gold
Physical gold in your possession is the ultimate form of protection. Gold coins are the most common way of purchasing gold. These can be either bullion or numismatic coins. In short, bullion is equivalent to money, whereas numismatic coins carry a collectible value. Bullion is for those who want to hold gold. Numismatic coins are for speculators and hobbyists.
If you want to buy gold, you may consider 1 once gold coins, from a reputable seller. US gold coins hold their value well, but there are many other forms of investing in physical gold. I personally like 1 oz. American Gold Eagle coins. I’ve also bough 1 oz. Canadian Gold Maple Leaf coins.
When buying physical gold you’ll pay a premium over the spot price. This can easily be 5% or more. Given this, I tend to hold gold as a long term investment.
I’ve bought gold and silver online from various places, including Goldmasters.org and Goldline.com (not sponsors).
Investing in Gold Stocks, Funds, ETFs, etc.
Despite my preference to stay away from stocks, I maintain stock positions in certain mining companies, mining mutual funds, and gold and silver ETFs. These investments are more speculative than physical gold and as such they bring a higher degree of risk, but they also bring higher potential for growth.
When gold and silver prices go up, these securities shoot up much higher than the price of their corresponding metals. The opposite is also true. When gold and silver prices go down, these mining companies take a hard hit.
Taxes
I am no expert, but I understand for tax purposes physical gold is considered a collectible by the IRS. This generally means gold is taxed at a higher rate than regular capital gains.
How Much Gold Should You Own?
Most experts recommend owning upwards of 10% of an investment portfolio. However, if you are new to precious metals it may be wise to target a lower percentage, say 5% to start with. This will allow you some time to learn about the different products, fees, storage options, etc. And once you are more comfortable with these things, you can increase your holdings to 10% of your portfolio, or whatever fits your investment needs.
At some point, your portfolio may include physical gold, mining stocks, and perhaps even gold related speculative investments. Below is a chart from zealllc.com, which suggests a form of balancing a gold portfolio. This is for more advanced gold investors, but I thought it was worth sharing.
Investing in Silver
Similarly to gold, silver has a history of being used as currency and a hedge against inflation. Although silver has more industrial applications than gold, it is also more abundant than gold.
Silver tends to be significantly more volatile and susceptible to speculation than gold. When gold shoots up, silver follows with much more momentum. The opposite is also true. When gold goes down silver goes down further.
If you want to include some silver in your portfolio you may consider U.S. 90% Silver Coins Pre-1965. You can buy these coins in small amounts. I’ve also purchase silver bars of various sizes.
Storing Gold and Silver
Whether you own the physical metal and you store it yourself or have someone else store it for you, storage could be a bit of a challenge. Obviously, the appeal to owning physical gold and silver is to have it in your possession. In which case, you may be at risk of theft or even losing it.
Losing it? Well yes. One time I was traveling with a one once gold coin and ended up taking it with me to Disneyland, where we were heading for a family vacation. I didn’t feel comfortable keeping the coin in my pocket, so I gave to to my wife, for safe keeping. She placed it in a secret place. So secret that we both forgot about it until about a week later, when we were back home. By then we concluded that we must have left it in the hotel. The hotel staff assured us it wasn’t there. So, we figured someone got blessed with a nice gold coin. Months later my wife used up the last tissue in a Kleenex box, and then she noticed a gold coin inside the box.
Suffice to say that some thought must be given to storing your precious metals. The article Owning Gold is One Thing, Storing it Quite Another discusses this subject.
The Bottom Line on Why You Should Own Gold
The bottom line is all paper currencies, including the dollar, have no real assets backing their value. Governments keep changing monetary policies and banks keep printing paper money. As such, all these currencies are losing value with inflation. Thus, your hard earned money has less purchasing power with each passing day. Even if you are earning interest in a savings account, the reality is you are losing money by keeping your money in the bank.
Gold, on the other hand, has real value, which provides a great hedge against inflation. Furthermore, gold’s demand is likely to continue to increase, as people become aware of the reasons why they should own gold. In summary, gold is a safe haven investment, it has the potential to grow, and it provides for a great strategy to diversify a portfolio.
I would like to encourage you to take a small step today. That small step could be learning more about gold and silver, it could be an actual purchase of gold or silver, or it could be simply evaluating how diversified your portfolio is. Heck, think how much fun it would be to hold a gold coin in the palm of your hand.
At the end of each article I have been suggesting a book relevant to the topic discussed. Regarding gold and contrarian investing, I can’t think of a book that will match the content in Adam Hamilton’s website. If you want to dive deeper into contrarian thinking, speculation, gold, silver, and other such investments go check his website at Zealllc.com.
Moving Forward
Moving forward, I intend to touch on the other elements of the ‘Bridge to Financial Freedom.’ However, I am also eager to discuss real estate and business valuations. I realize that much of what I’ve written about may seem basic to some readers, so it is time to speed things up a bit.
As always, please drop me a note and let me know what other areas of business and finance you’d like to explore. Then I’ll write more about your suggested topics as we pursue knowledge, financial success, and financial independence together. In addition, you can also follow me on Twitter at @Cash_Keen
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