Gold prices have sure lost their luster lately. It’s a continuation of a sad story that has gone on for several years now.
In 2013, gold prices declined nearly 30%, wreaking havoc on the SPDR Gold Trust (ETF) (NYSEARCA:GLD) and other gold funds. A year later, declines slowed, but gold was still 2% in the red. So far this year, gold prices have moved a lot, but ultimately finished the first quarter flat.
So, is there hope for gold finding a bottom? For investors are considering buying in, there are plenty of options, including GLD, the iShares Gold Trust (ETF) (NYSEARCA:IAU) and the ETFS Gold Trust (NYSEARCA:SGOL). These funds hold vaults filled with gold bullion, and their stock prices fairly accurately track the movements in the spot price of gold.
So, should you buy gold (presumably through one of these funds, like GLD)? Let’s take a look at the pros and cons to find out.
Pros on Gold Prices
Safe Haven: Gold has traditionally been considered a form of protection during times of global distress. This is due in large part to gold’s historical role as the backing for currencies (e.g., the “gold standard”). A good example of how gold prices spike in times of duress, check out 2009, when GLD posted a return of 24% against losses in just about every other asset class. Gold prices continued to run in 2010, ramping up another 30%.
Peak Gold: It is tough increase the production of gold, as has been noted by miners such as Barrick Gold Corporation (NYSE:ABX), Newmont Mining Corp (NYSE:NEM) and Goldcorp Inc. (NYSE:GG). To find new deposits often means higher expenses related to digging deeper, and also entering regions of the world that are politically unstable.
But, the supply situation may get even tighter with the launch of the Apple Inc. (NASDAQ:AAPL) Watch. Yes, the company’s 18-karat gold watch could require buying up as much as 750 tons of gold per year, according to the Wall Street Journal. Keep in mind that annual global production is only about 3,000 tons.
Central Banks: Since 2009, central banks have been buying more gold. But, according to Bloomberg.com, the demand has been primarily from emerging markets and developing nations such as India, Turkey and Russia.
Data regarding China has, unfortunately, been spotty. But, it would not be surprising to learn that there has been increased buying there as well. Keep in mind that — after the financial crisis — central banks have been trying to diversify away from the U.S. dollar. No doubt, the recent surge in the currency makes this strategy look even smarter.
Cons on Gold Prices
U.S. Interest Rates: Generally, there is an inverse relationship between gold prices and interest rates. That is, when one rises, the other falls. There are several factors for this. One is that gold does not provide any yield. So, as interest rates rise, gold looks less attractive, and investors would rather seek havens like Treasuries.
Next, when interest rates rise, the value of the U.S. dollar often does, too. But, in global markets, gold is traded in U.S. dollars. Thus, there is often depreciation in the value as the dollar increases. Of course, it appears that the Federal Reserve is likely to increase interest rates in the coming years. If so, there could be a lot of pressure on gold prices.
Is Gold Dead Money? Some think so. In fact, legendary investor Warren Buffett has been quite vocal in his disdain for gold as an investment. He once stated, “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.”
Consider that gold is a “negative-yield” investment. In other words, since it does not produce any profits or dividends, there is an ongoing net cost for storage and insurance.
Bear Markets: Gold has suffered long periods of depressed prices. For example, during the 1980s and 1990s, the precious metal was barely treading water. Instead, investors focused primarily on stocks and bonds to seek out higher returns. Interestingly, it was not until the long-term bull market in financial assets ended in the late 1990s that gold came back to life.
If anything, the strong stock and bond markets during the past few years has probably pulled money away from gold. And, if there is truly a secular bull market, then there could be another prolonged bear period for gold.
Verdict
While gold has been in the bear phase for a few years, there are signs that things could improve. Supply remains tight and there may be wild cards like the Apple Watch. But, it also appears that central banks are viewing gold as a form of protection, which should bolster demand.
Then, there is the safe-haven factor. All in all, the geopolitical environment is dicey. Just some of the hot spots include Syria, Iraq, Yemen, North Korea and the Ukraine. So, if there is crisis — which certainly seems likely — gold will be a good way to help insulate your portfolio.
So, should you buy gold, say, with the GLD ETF? 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.
