So far this year, gold has lost some of its luster, with its value falling by over 24%. If there is no rally during the rest of the year, gold will actually have its worst performance since 1981 — certainly ominous since that was the start of a 20-year bear market.
Yet it’s important to note that gold has posted a gain for every year from 2000 to 2012. In other words, it is more than reasonable that there should be some type of major pullback.
But is it a good time to buy now? Or should investors will be cautious? To see, here’s a look at the pros and cons:
Pros on Gold
Safe Haven. When it comes to owning gold, this is the common reason. It is considered by many to be an alternative to a currency — that is, a store of value, especially during times of distress. This has proved to be the case during such recent periods like 9/11 and the financial crisis in 2008 (during this time, it was only a small number of assets that increased in value). Whenever there is a drop in the value, the buzz is often that gold has suddenly lost its “safe haven” status. But again, the precious metal has been a popular store of value for hundreds of years. Besides, there are no signs that the world has entered a phase of bliss. Just some of the possible issues include budget battles in DC, potential bubbles in real estate, foreign policy hotspots like Iran and North Korea and instability in emerging markets.
Gold Supply. As with many other commodities, it has become harder to find deposits. And even when there is a new discovery, the costs of extraction are generally high. As a result, the overall production rates have been tepid from miners like Barrick Gold (ABX), Newmont Mining (NEM) and Goldcorp (GG). And with the recent plunge in the price of gold, it is likely that there will be even less production.
Stock Market. The stock market has been an easy place to make money lately, but there seems to be a disconnect. After all, corporate revenues and earnings are still fairly moderate as the economic recovery has been a let-down. Yet investors have been aggressive with stock buying and IPOs, which is a traditional sigh of frothiness. If there is a big pullback, then investors will scramble for alternatives — and gold may be an attractive option.
Cons on Gold
Central Banks. Since 2010, they have been strong buyers of gold. A key source of demand came from emerging markets, where many countries were piling up budget surpluses. By purchasing gold, it was a way to help diversify the bulging currency holdings. However, this year the demand has flagged as central banks have devoted more firepower to support domestic currencies. Volatility has been high because of recent indications from the Federal Reserve that there would be tapering, which could pull in more capital because higher interest rates. Consider that the consensus forecast is that gold buying will drop about 34% this year.
Inflation Hedge. This is one of the advantages of holding gold. With the surge in easy money across the world, many investors believed that inflation would spiral, which would drive the price of gold. But so far, there are few indications of inflation. The fact is that the world economy has remained sluggish, which has meant moderate increases in wages and consumer spending. In a recent report, the Labor Department said that prices rose only 1.2% in the year ended September.
Dead Money? Gold may be shiny but there are few commercial applications for it. Oh and of course, it does not produce any dividends. If anything, there is an ongoing cost for storage and insurance. This is why gold is known as a negative-yield investment. Given all this, there are some well-known investors who shun gold. One is actually famed billionaire Warren Buffett, who once said: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
The negative sentiment is widespread for gold. As indicated from a recent article in Bloomberg, hedge funds have been dumping their holdings.
But again, gold is still likely to be a safe haven. And this is why it can be a type of insurance policy for a portfolio. For example, legendary investor Byron Wien — who is the Vice Chairman at the Blackstone Group (BX) — recommends about a 5% stake.
Plus, it’s fairly easy to get exposure to gold, such as with exchange-traded funds like the SPDR Gold Shares (GLD).
So should you buy gold? Yes — if you’re looking to provide some insurance for your portfolio, the pros certainly outweigh the cons.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.