There’s that old yarn about how those who forget history are doomed to repeat it. Rabid fans of gold would do well to remember this because gold bubbles have bankrupted many investors in the past — and in fact have resulted in the fall of empires, not just investment bankers.
Consider that at the dawn of the 16th century, Spain was one of Europe’s wealthiest nations. By 1598, it essentially was bankrupt. Why? Because despite the looting of the “New World” and a horde of new gold flowing into the treasury, it was spending well beyond its means because of imperialist policies and costly wars. Beyond that, the supposed riches taken from South America created a false sense of security, and Spain failed to focus on any industry other than trade in precious metals. That resulted to widespread inflation that took a deep toll on Spanish commoners.
There are a host of lessons to be learned here, and I expect the comment section at the end of this article will carry on a spirited debate about the prospect of America’s current debts, costly wars and failure to create 21st century industries and jobs. But the “investable” idea I want to focus on is much simpler: That the illusion of wealth sometimes can be more destructive than the reality of austerity.
Or put another way, it’s the same psychology that plagues many lottery winners. Otherwise level-headed folks turn into spendthrifts or lose all common sense with the influx of a few million bucks.
Gold has a way of doing that to people these days.
We see headlines trumpeting gold touching “records” above $1,900 — though the true inflation-adjusted high of gold was its 1980 peak of $850, which is about $2,400 in today’s dollars.
We see folks touting the fact that gold is up more than 50% in the past 12 months — but not that the precious metal is significantly above moving averages, and that going “parabolic” might just mean gold is grossly overbought.
We hear goldbugs tout how the metal is truly an “outsider” investment that isn’t subject to the shenanigans of Wall Street or banks. But the SPDR Gold Trust (NYSE:GLD) is now the largest exchange-traded fund, surpassing the SPDR S&P 500 ETF (NYSE:SPY) in assets. Sounds pretty mainstream to me.
We hear myths about how gold has no correlation to the stock market, and thus is a great contrarian investment. In fact, if you look at the past 12 months, gold is very much correlated to the stock market — it performs almost exactly in inverse. While it’s fair to say gold is a way to play the other side of the trade, it’s not necessarily a way to diversify your portfolio beyond the equity market.
All this is not to say that gold is useless in your portfolio, or even to say that gold will not keep rising in the months and years ahead. But please, know your history. When the gold bubble popped in the early 1980s, investors who rode the precious metal all the way down lost more than 50% in the flop. And while gold wasn’t the only reason the Spanish empire fell, the illusion of wealth certainly convinced leaders that everything was just fine when it was anything but.
Gold is very volatile and has the ability to destroy your retirement funds, as well as build them up. Like all investments, you must think rationally about the risks and rewards of the precious metal and just how much of a role it will play in your portfolio.
Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.