Answers to Big Questions About Gold

by Kyle Woodley | April 12, 2012 9:00 am

Answers to Big Questions About Gold

After a screaming run in 2011, gold (NYSE:GLD[1]) has hit a bit of a hitch this year[2]. The yellow metal’s worth did finish the first quarter in the black, but it has been in steady decline since February. Still, many analysts think gold will climb from current valuations around $1,660 to $1,900 by year’s end, so there’s more than enough reason to get in.

Of course, you can’t just hop into gold all willy-nilly; you need to have a plan. So today, InvestorPlace is talking to Edmund C. Moy, a consultant with Morgan Gold[3] and a former director of the U.S. Mint, to discuss a few things investors should know when dealing with gold. At the Mint, Moy was responsible for the production and distribution of about 10 billion to 20 billion coins annually, as well as maintaining physical custody and protection of the nation’s $100 billion in gold and silver assets.

OK, most people’s gold hoards likely will be a touch less than that. Still, having a well laid-out plan and knowing what to watch for is vital — regardless of the size of your investment. Moy sounds off on these topic, as well as a growing issue in the coin world.

Q: What economic issues should investors keep an eye on if they plan on jumping into (or are already invested in) gold?

A: The strongest influence on the price of gold is the value of the dollar. Generally, when the dollar falls, gold rises and vice-versa. That is why gold is a natural hedge against inflation.

Those who are interested in the potential rise in gold prices should look at the types of economic and political instability that will drive the dollar’s value down. So investors should look at governments’ fiscal and monetary policies, like the level of national debt and central bank balance sheet expansion.

On fiscal policy, will our economy grow more aggressively and therefore bring in more tax revenue to reduce the deficit? Will Congress and the president agree on a budget that reduces the deficit or even generates a surplus? If the answer is no, then gold prices will likely rise.

On monetary policy, if America cannot tame its record deficits and national debt or continue the economic recovery, will the Federal Reserve to engage in another round of quantitative easing? If the answer is yes, then gold prices will likely rise.

Other key areas to watch are the European debt crisis, escalating tensions in the Middle East and a slowdown in growth in India and China.

Q: One of the biggest stories in gold is China’s rampant demand — but something that seems overlooked in most headlines is that India is the top market. That looks poised to change soon, but how much attention should investors give one, the other or both of these countries?

A: Price is a function of supply and demand. The supply of gold is relatively fixed, with only relatively small amounts of new gold being mined every year. The demand for gold is relatively flexible and is significantly influenced by its desirability among investors as a hedge against inflation.

But there are other factors that influence the price of gold, like the industrial use, jewelry demand and individuals using gold as a storehouse of wealth. India and China’s robust economic growth has increased the demand for gold for industrial use in electronics, computers and industrial glass.

There is also a cultural affinity in both countries’ cultures for gold. As a result of a growing number of citizens becoming more prosperous, the demand for gold jewelry has risen dramatically because it is a personal status symbol. It is also very popular in both cultures to give gold as a gift, especially at weddings, graduations and holidays like Diwali or the Chinese New Year. And due to the checkered history of unstable currency and banking systems, many Indians and Chinese buy gold bullion, in coins and bars, as a storehouse of personal wealth.

So yes, investors who believe that demand influences the price of gold should definitely pay attention to India and China.

Q: What part should gold play in aggressive portfolios? Long-term conservative portfolios?

A: The goal of an aggressive portfolio is appreciation with a high degree of tolerance for risk. This is accomplished with a greater weighting toward stocks with some consideration toward bonds, cash and gold. Given the recent stock rally and what some assume to be the end of gold’s dramatic bull run over the last few years and the gold price plateau over the past few months, it would be easy to minimize any position in gold. But that would be a mistake.

From January 2000 to December 2011, gold was up 440.4% while the Dow was up 5.5%, the S&P down 14.1% and the Nasdaq down 37.3%. As recently as 2011, gold still outperformed all three stock indexes: gold up 10.3%, the Dow up 5.1%, the S&P down 1.6% and the Nasdaq down 2.5%. Because our deficit and national debt is at record levels, coupled with Congress and the president unlikely to meaningfully address the fiscal policies that led to our problems, gold prices have room to rise.

The goal of a long-term conservative portfolio is to generate returns and provide a stable income while reducing the likelihood of a significant drop in the value of the portfolio. This is mostly accomplished with a greater weighting toward bonds and an appropriate allocation in gold. In addition to buying gold bullion coins and sometimes gold bullion bars, many investors elect to convert a portion of their IRA into a gold IRA.

Depending on the size of the portfolio and the goals of the investor, the gold allocation is usually between 5%-10% but can be as high as 15%. If we are entering into a new era of prosperity with a long bull market for stocks, a robust economy, federal budget surpluses and declining national debt, an investor might consider a gold allocation closer to 5%. But if we are entering into an era of greater economic and political instability with a bear market for stocks, a slow economy, big federal budget deficits and growing national debt, an investor might consider a gold allocation closer to 15%.

Personally, I am 10 to 15 years away from retirement and have a moderately aggressive portfolio that is adjusted for a lower tolerance for risk. I have set my goal to allocate 10% of my portfolio in gold and own both a gold IRA and gold bullion coins (made by the United States Mint), which I purchased from Morgan Gold.

Q: Not wanting to miss the opportunity to ask someone with extensive knowledge of coin currency … What are your thoughts on Canada’s discontinuance of the penny, and whether the U.S. should follow suit?

A: The trend among economically developed countries is to eliminate their lowest-denomination coin, add a high-denomination coin and shed their lowest-denomination bill.

The reason is economic. Due to inflation, the lowest-denomination coin has little utility, yet because it is made of metal, costs more to produce than what it is worth. And because bills are made of paper, their lifecycle is much shorter than their equivalent coin, making coins much more economically feasible over time. Canada, Australia, New Zealand and the euro are all variations on this theme.

But here in the United States, old habits die hard. Usually obsolete coinage (does anyone remember a half-penny or half-dime?) ceases to be made by the United States Mint due to lack of demand. Congress does have the ability to eliminate them, but they have seldom exercised that authority. Who wants to go down in history for getting rid of Abraham Lincoln? Or getting rid of the greenback, which has been the symbol of American economic strength around the world?

Eliminating the penny would save the taxpayers $60 million per year. Eliminating the dollar bill and substituting the dollar coin would save the taxpayers $184 million per year. That is $2.44 billion over 10 years, which is not exactly chump change.

Recently, because of the potentially harmful impact of the next round of budget sequestration, Congress is starting to look at alternative ways to cut the budget and is debating a proposal to eliminate the dollar bill and substitute it with the dollar coin.

Ready to jump in? Here’s two easy ways to invest in gold.[4]

Kyle Woodley[5] is the assistant editor of InvestorPlace.com[6]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @KyleWoodley[7].

Endnotes:
  1. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD
  2. hit a bit of a hitch this year: http://investorplace.com/2012/04/golds-ready-to-shine-in-q2-if/
  3. Morgan Gold: http://www.morgangold.com/
  4. Here’s two easy ways to invest in gold.: http://investorplace.com/2012/02/2-easy-ways-to-invest-in-gold-gld-iau-gdx-gdxj/
  5. Kyle Woodley: http://investorplace.com/author/kyle-woodley/
  6. InvestorPlace.com: http://investorplace.com/
  7. @KyleWoodley: https://twitter.com/#%21/kylewoodley

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