Interested in Gold? Investor Beware
October 11, 2010
If you don’t own gold in your portfolio are you getting antsy to buy? With gold hitting new highs, our advice to investors is be wary of the herd mentality.
In April 2009, we wrote about the popularity of gold and how one might go about making an investment in this precious metal. In that article, we noted that investors have gained new access to this asset class through the use of ETFs (exchange-traded funds) and other securities that mimic the behavior of gold prices. Last week, gold prices hit new highs and, again, many people are wondering if they should be adding gold to their portfolios.
Why the Rush to Gold?
After taking a roughly twenty-year hiatus, gold moved back into the spotlight over the last several years with its notable rise in price. Gold prices have more than tripled from approximately $430 per ounce in early 2005 to nearly $1,350 per ounce this past week. This increase has been fueled by the financial crisis, the severe recession, crashing stocks, low bond rates, inflation concerns, and easier access to gold investments. While there is no dispute that early gold investors have done well, we would advise a cautious approach going forward.
Herd Behavior
What is always interesting about the investment markets is that many individuals want to buy assets after they have risen in price. The greater the rise, the greater the desire to buy. This seems counterintuitive, as economists would tell us that most people are rationale and like to spend less on purchases. With goods and services, this typically holds true. However, with investing, it still seems very hard for investors not to get caught up with the herd. In many of these cases, the justification starts out with “this time is different because..”, but then it turns out the trend cited in the rationale fades like the falling tide.
With gold, no one can say for certain that this is bubble territory or that it will not continue to go up to $2,000 per ounce. However, investors who are interested in gold should be aware that past results are rarely similar to future returns.
Tulip Mania
We can remember the technology stock and real estate bubbles very clearly. While this behavior may seem new, bubbles have been a part of our economic history for many years. One of the most well cited early bubbles occurred in the Netherlands in the 17th century. Known as “Tulip Mania” the market for tulip bulbs created immense wealth at its apex, but was ruthless when it turned. Tulip bulbs became so popular and profitable for the upper class businessmen that ordinary families, wanting to participate in the profits, took their entire savings to buy hybrid bulbs. As the craze hit its peak, the supply of tulip bulbs outsized the demand, and the market collapsed.
Summary
Following the herd in investing can sometimes lead to disappointing results. While gold prices now dominate the financial headlines, investors should steer clear of making purchases just to follow the crowd.
