Gold prices were quite volatile in 2011. There were a lot of fireworks for the precious metal, not the least of which was a new record for gold prices in 2011 — the London fixed price of gold hit $1,895 twice in early September. Spot gold prices for immediate settlement, also known as gold futures to some, briefly cruised to $1,916 per ounce around the same time.
Click to Enlarge Investors who bought gold in 2011 were richly rewarded. Year-to-date, the precious metal is up 25% — with very few periods where gold moved down instead of up.
But gold investors typically are less concerned with the past than they are curious about the future. Specifically, what will 2012 gold prices hold for precious metals and commodity investors?
In a nutshell, it should be more of the same — strong demand from risk-averse investors, the prospect of high inflation propping up commodity prices and hopes of yet another record for gold in the new year.
Let’s take a look at these three issues in more detail, and also the best ways to invest in gold to profit from these trends:
Gold Price Driver #1: Fear
The correlation between rising gold prices and rising uncertainty is clear. Whether it’s because you’re afraid to take a risky play in this shaky stock market or whether it’s because you fear political and economic shenanigans are devaluing paper money, gold appeals to investors of all stripes when fear is on the rise.
Just look at a history of gold prices, and you’ll see the biggest rises were amid some of the biggest periods of uncertainty. Adjusted for inflation, the true record of gold prices is roughly $2,500 in today’s dollars based on the peak levels of the precious metal in 1980 — a year during which the Cold War was raging, inflation was sky-high, the S&L crisis was starting to heat up and super-expensive oil threatened the global economy.
The reasoning is simple: Gold has been valuable since the days of the pharaohs and will remain valuable as long as it is a rare commodity. When you are more concerned with finding a place to store your money safely than growing it aggressively, gold is your fallback option.
What uncertainties lie ahead? Well, a short list is the ever-raging euro zone debt crisis, the prospect of a debt crisis and further credit downgrades in America, persistently high unemployment, geopolitical unrest due to the “Arab spring” and the turmoil of the 2012 presidential elections.
Seems like fear will be in favor again in 2012, which bodes well for gold investors.
Gold Price Driver #2: Inflation
Another big reason for people to jump on the gold bandwagon is because of commodity inflation. Because of monetary policies in the U.S., including quantitative easing and ultra-low interest rates, the inflationary picture is looking ugly to many investors.
Here are some headlines to chew over:
- In November, the average cost of a Thanksgiving dinner jumped a whopping 13% over the previous year because of inflation.
- The annual inflation rate peaked at a red-hot 3.9% this fall and has cooled to “only” about 3.5% currently.
- Many experts, including renowned Quantum Fund founder Jim Rogers, have ramped up criticism of inflation methodology, saying it paints a rosier picture to protect politicians. Considering the ugly outlook with these numbers, it’s disturbing to imagine they are even worse if this criticism is valid.
The biggest fear during the financial crisis was a Japan-style deflationary spiral — where falling prices lead to decreased demand which leads to falling prices, and so on.
America has tried to inflate its way out of such a disaster. It worked. But now we are left with the hangover of inflation as a result, and that in turn is going to take time, policies and patience to resolve.
In the meantime … buy gold.
Gold Price Driver #3: Legitimate Investment, Not a Bubble
It would be silly to talk about these macroeconomic trends and ignore the plain fact that because gold is an investment, it is subject to the same buying rush and speculation as any other investment. The only question, then, is whether gold is in a bubble because of irrational buying or whether it is a legitimate investment.
There are a few signs of a bubble, surely. Some people expect gold, like real estate circa 2005, to only go up — influenced no doubt by late-night “cash for gold” infomercials.
But there also are a host of signs that gold investment is sustainable at these levels and will not just evaporate. Exchange-traded funds like the SPDR Gold Shares (NYSE:GLD) provide millions of Americans access via their IRA — putting gold investment plainly in reach. GLD actually is managing more money than the SPDR S&P 500 ETF (NYSE:SPY) these days! Sure, some of that money could rotate out to other assets. But much of it likely will stay and provide a floor for gold prices.
As for future investment, the previous two points show legitimate reasons for investing in gold along with the claptrap about “guaranteed” returns in the precious metal. So while there are suckers buying in, smart folks continue to buy into gold, too. Besides, the constant drumbeat of stories predicting a gold bubble in 2011 indicates that enough skepticism exists to keep gold prices honest.
As with any investment, there is no way of knowing what 2012 will hold for gold. But fears of a bubble should not deter you from buying gold in the new year.
3 Best Ways to Invest in Gold
There are a handful of ways to invest in gold, and each has its own costs and benefits.
The most common option for investors these days is via ETFs like the aforementioned SPDR Gold Shares or the iShares Gold Trust ETF (NYSE:IAU). The pair of funds have more than $80 billion in physical gold assets, proving their popularity. GLD is 10 times the size but has a 0.4% expense ratio vs. 0.25% for IAU. Over time this can eat into your performance, but the ease of trading and the lack of physical gold in your possession is attractive to many folks.
Less accessible is the idea of owning physical gold in the form of bars or coins. This, of course, saves you the management fee — but logically it should involve an investment in a safe or other security so your hoard doesn’t get stolen. If you have a big stash, the cost of a sizable safe could be the least of your worries since a single cubic foot of gold bars weighs more than 1,200 pounds! That’s a big logistical mess. Also, trading in physical gold can be risky if you don’t do your homework — gold coin scams are popular and costly for investors. Selling also is problematic for physical gold because you can’t just dump shares on the open market like the gold trust ETFs. You have to find a human buyer willing to pay what you’re asking.
A less direct way is to invest in stocks of gold miners like Goldcorp (NYSE:GG) or Randgold Resources (NASDAQ:GOLD), or diversified ETFs like the Market Vectors Gold Miners ETF (NYSE:GDX) that own shares in a bunch of these stocks. But remember that you are investing in a stock as much as gold, and your investment will not track the movement of gold prices 100%.
Jeff Reeves is the editor of InvestorPlace.com. Write him at firstname.lastname@example.org, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.