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Gold: hedge, yes

Fred Taylor //September 14, 2011//

Gold: hedge, yes

Fred Taylor //September 14, 2011//

Fresh concerns about the economy coupled with poor stock market performance have ignited a new gold rush among investors. While gold might look like the surest bet in a field of uncertain investment vehicles, the commodity still carries a good amount of risk and generates no income to its owner.

First, let’s consider why gold has become so popular. Quite simply, investors are buying gold because they don’t know what else to with their money. Money market yields are at zero, the interest rate on a 10-year U.S. Treasury bond is just 2 1/4 percent and the stock market has posted a number of 400 to 600 point swings in either direction. Real estate – once a safe haven – also continues to struggle, with housing values down 20 to 30 percent.

Gold, on the other hand, has risen in recent years, going from around $550 in price in early 2006 to more than $1,800 an ounce today. It’s also a relatively simple commodity to buy. The exchanged traded fund GLD, trades daily just like a stock, so it is extremely easy to participate in the speculative frenzy of buying gold. That ETF has a higher market capitalization than the S&P 500’s exchange traded fund – reflecting the significant surge in demand for gold.

But before you jump on the bandwagon, consider the recent losses gold sustained after hitting a high of $1,917 an ounce. The commodity fell more than 5 percent in two days, prompting talk of an impending correction. Now, I don’t know where the price of gold is going, but I do know that buying at these levels can be dangerous. If you are wrong, it could be analogous to buying Cisco Systems in March of 2000, when it was trading at $80 a share and had the largest market capitalization on the NASDAQ. Today, Cisco trades at $15 a share.

I am not suggesting that gold will fall 80 percent over the next 11 years. But if you buy too high, any drop in price can be devastating. The risk is especially high for investors close to retirement, who can’t tolerate the potential volatility gold carries. And if you look at the long term, gold isn’t a proven performer. Since 1929, gold has offered an average rate of return of about 5 percent annually, while stocks returned an average of 9 percent during that same period.

The market holds a more secure option in the form of large-cap, multi-national, dividend paying stocks. With the recent 2000-point drop in the Dow Jones Industrial Average since July, one could argue that the markets are oversold. Quality, dividend-paying stocks are considered attractively valued on a historical basis, especially after the 18 percent increase in earnings this past quarter. These companies are trading at only 10 to 12 times next year’s earnings and many are paying dividends in excess of 3 percent. Since 1986, over 40 percent of the return on the S&P 500 has come from dividends and in a zero growth economy this will become even more paramount.

Gold can be used in a portfolio as a hedge, not an investment. You can buy a limited amount of gold to hedge your other investments. This is called diversification. Putting all your eggs in the gold basket may sound tempting in era of uncertainty, but that approach won’t result in a strong long-term portfolio or provide any reasonable amount of income.

For our Northstar clients, I would rather they receive an attractive dividend yield that has been increasing by 5 percent to 7 percent a year from large cap US multi-national companies who are selling to the people in China, India, and Brazil than hoping I buy gold today at $1,800 and sell it six months later at $2,200.

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The material in this column does not constitute investment advice and is not a complete analysis of the issues involved. Consult your individual financial advisor prior to making any financial decisions. Past performance is no guarantee of future results.
About Fred Taylor:
Fred Taylor co-founded Northstar Investment Advisors, LLC in 1995. The firm specializes in managing personalized investment portfolios for individuals, families, and retirees with a focus on income generation. He is a member of the Colorado Forum and also served as an economic advisor to Colorado Governor Bill Ritter from 2008 to 2010.