Most everyone remembers the run up of the price of tech stocks about ten years ago. It was commonly referred to as the dot-com bubble. The technology-laden NASDAQ composite index went from roughly 800 to 5000 in six years, only to have it come tumbling down. In reality, the value was just not there.
More recently we’ve had the housing bubble when home prices were going up 20 to 30 percent a year. In some cases the price of a house doubled in less than 4 years, only to have the bubble break and prices dramatically fall. What went up in value has come crashing down.
In the last five years, the price of an ounce of gold has gone from $450 to over $1100. Its rapid increase in price looks very similar to what happened to the price of tech stocks in the 90s and housing prices this decade.
Gold prices were set years ago by the government. Since the dollar was backed by gold, there were small increases over time but no wide variation in price. In the early 1970’s the United States went off the gold standard and now the price fluctuates based on demand.
Gold is a very unusual investment. It has no interest paid from owning it, there is no dividend stream, and there is no cash flow generated from it in order to establish a value. There is no value derived from owning it as there is with owning a home. The value is now decided by supply and demand.
There seems to be three reasons for the increased demand: the fear of inflation (due to this country’s large amount of deficit spending), the media needing something to talk about and a lot of companies involved in selling gold doing a lot of advertising.
A fourth component to the increased demand could possibly also be what is called the “herd mentality”. If as an investor, you are hearing from your friends and neighbors on how their recent investment in gold has been up 100% and they plan on buying more and you would want similar returns so consider buying gold as well. This is exactly what happened with both the tech boom and the housing boom. What generally happens when you follow the herd is that you usually end up stepping in what the herd has left behind.
There are also definite problems in owning gold. In many cases, there are very high commissions built into the price of your purchase. When you need to sell the gold you never get the current market rate because of the transaction costs.
As far as an inflation hedge, you can’t hold enough gold to hedge your other investments because there’s just not enough of it. Once this is better understood the demand for gold may follow the same “ bust” as occurred with tech stocks and house prices.
Then there is the issue of storage. Are you going to keep it in your closet where it would be subject to theft? Putting it in a safe deposit box is not practical because it is so heavy. Do you pay to have it in a secure storage facility?
While the drop in gold prices have not occurred yet, the upward climb in price has a scary similarity to the tech stock and house price boom and then bust.
This article is for informational purposes and should not be taken as legal, tax or investment advice.
Photo by: Mykl Roventine