Should investors be buying gold?

A good question for today.

An equally good question is should you rely on expert advice?

For those who follow my blogging, I am not a big fan of experts. Their track records are weak as prognistigators and their ability to outperform the markets is questionable. Plus for every expert that takes one position, you can find another who advocates the opposite position.

Take gold for example.

Some respected analysts and firms are raising their price targets for gold given current economic conditions. This Wall Street Journal article provides several examples of investment firms raising their forecasts. JP Morgan expects the price of gold to reach USD 2500 per ounce by year end.

This seems to indicate that gold is a buy for investors.

But Do the Experts Get Ever Get it Right?

But wait. If you read the article you will note that the firms’ forecasts were way off previously.

Just how badly did some institutions get their gold outlooks wrong? A year ago, most banks and trading firms expected gold to average somewhere around $1,200/oz, with forecasts ranging broadly between $1,147/oz (Deutsche Bank) and $1,260/oz (Goldman Sachs). By the end of 2010, gold was up 30% from its opening price at $1,431/oz. The previous year, spot prices had risen 39% after a relatively flat 2008 and a 33% rise in 2007.

Predictions for 2011 were more varied: generally a year-ago analysts were tipping the market to rise further—with the exception of Barclays Capital, which estimated the precious metal averaging a lower $1,150/oz and HSBC, which forecast gold at $1,025/oz.

In 2011, the market is up 25% so far. No wonder analysts are revising their forecasts.

If the experts were so inaccurate on previous estimates, who is to say they got it right this time.

And What About the Other Experts?

While some experts say now is the time to be buying gold, other experts feel differently.

Take respected investor, Jim Rogers. He has stopped buying gold.

“I wouldn’t buy more gold and silver right now”. “I don’t like to jump on a moving bus”.

That does not mean that Mr. Rogers believes gold will fall in value – he does not – but that the upside may not be there for the risk level. And that there are better investment opportunities out there than gold – he likes agriculture.

And some even provide reasonable arguments as to why gold may be currently overpriced.

What Should You Do?

Tough call.

Personally, I still like gold. The reasons (in short) being that it is a safe haven, a hedge against inflation, and given the way many governments have destroyed their economies there are few other decent investment options available.

That said, I agree with Mr. Rogers in that it is never a good investment strategy to be one of the last investors to the party. I am not saying that gold is an investment bubble about to be burst, but buying late into a bull market does leave one open to the risk. Learning to properly identify an investment bubble may save you some capital.

Buy and Hold, But Rebalance

Again, here is where the “buy and hold, but rebalance” approach works well.

Your Investment Policy Statement should determine a suitable asset allocation for you. This may include precious metals or shares in companies that operate in these industries.

Say you have a portfolio of USD 100,000 and your asset allocation recommends 5% in gold. Perhaps you acquired 8 ounces when gold was USD 625 per ounce. Today your portfolio is still worth USD 100,000 given poor equity performance. However, at today’s gold prices, your 8 ounces are worth USD 14,000 or 14% of your total portfolio.

If you rebalance to bring your actual asset allocation back in line with your target, you would sell about 5 ounces to return to the USD 5000 or 5% level (note that you could rebalance in other ways to get your allocations back, but these will take time to implement).

In this way, you lock in some profits on your gold investment and protect yourself from price reversals. Yet you maintain some upside for future growth.

Do Not Forget Dollar Cost Averaging

Dollar cost averaging (DCA) is another strategy I recommend. It works well for assets that experience significant price volatility, such as gold right now.

Perhaps you intend to allocate USD 500 each quarter to gold purchases. 10 years ago, that may have bought you 2 ounces of gold each quarter. 6 years ago, about 1 ounce each quarter. Today you will need almost a year’s worth of saving to acquire 1 ounce.

As an asset becomes more expensive, you buy less of it. That also provides some protection against price reversals as you buy less at high prices.

DCA is also useful for those investing the turbulent equity markets. With the large short-term price fluctuations, investors trying to time the market for their purchases and sales may face difficulty. But if you believe that the long-term trend in equity valuations is positive (a questionable proposition it may seem to many at the moment), then this current volatility may allow you to purchase additional equities at sale prices.

Do I think the equity markets are good value at the moment?

Probably not given all the systematic risk issues impacting companies at this time. Uncertainty over interest rates, tax rates, currency valuations, availability of debt, consumer fears, etc., all have a negative effect on companies. And this is regardless from their own business operations and plans. So even good companies will be weighted down by systematic pressures.

But, assuming governments come to their senses and start taking measures to safeguard the future, there are definitely sectors and companies that will prosper down the road. So if you are using a DCA investment approach, continued purchases of equities may make sense.

If you have the technical expertise (individually or through a competent financial advisor), you may wish to consider a more tactical asset allocation approach. This attempts to take advantage of shorter term trends and expectations to shift higher percentages of capital into more promising markets and/or asset classes, while lowering allocations to those areas expected to underperform.

Not the easiest approach as it is difficult to time market movements. But, given the economic issues around the globe, there are trends already underway.

 

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