What Are the Risks of Investing in Gold?
Singaporean investors should allocate at least a certain portion of their funds to gold. The yellow metal has proved itself to be a near-perfect store of value and a safe haven in times of economic and political crisis for thousands of years.
It is not only individual investors who put their trust in gold. Governments and central banks consider it to be an “asset of last resort.” The Federal Reserve Bank of New York stores gold on behalf of the US government, foreign governments, and other central banks. In 2015, its vault housed approximately 508,000 gold bars, which had a combined weight of about 6,350 tons.
Source: New York Fed
But an investment in gold by an individual can have its downsides. Storing the precious metal safely is the most obvious problem. To keep its stocks safe, the New York Fed’s vault has only one entrance and that is protected by a 90-ton steel cylinder set within a 140-ton steel-and-concrete frame.
While individual investors cannot go to such lengths to keep their investment safe, they will have to spend a certain amount to store their gold in a secure location.
However, keeping your investment safe is only one of the drawbacks of putting your money into gold. Here are some of the risks that you should consider before deciding to buy the precious metal.
You don’t earn anything unless the price of gold appreciates
Practically every investment gives you a periodic return. When you buy stocks, you receive dividends. Bonds provide you with regular interest payments at a pre-determined coupon rate. If you purchase property, you will earn a monthly rent.
But an investment in gold does not give you a return. In fact, in the words of the legendary investor, Warren Buffett, all it does is “… look at you.”
If all the gold in the world were gathered in one place, it would form a cube 68 feet per side. The cube’s value? A massive US$7 trillion. That’s about ten times the world’s most valuable company, Apple Inc. But unlike a company, which provides a dividend, gold does not provide any return.
According to Warren Buffet, “… it’s a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage….”
Gold prices are unpredictable
Gold is essentially a “crisis commodity.” If the economy flounders and the growth rate remains low, the price of gold will rise. Conversely, if business and trade expand rapidly, you can expect the value of gold to fall.
There is also a direct inverse linkage between gold prices and interest rates. If higher interest rates are available, investors would prefer to liquidate other assets and put their money into bonds. As funds move into fixed-income securities, prices of gold will tend to soften.
The reverse is also true. As interest rates fall, gold values will rise.
Government and central bank intervention also play a role in the price of gold. When the economy slows down, central banks use quantitative easing to pump liquidity into the financial system in the hope that funds become easily available to entrepreneurs and businesses. This action pushes interest rates down and can lead to a rise in the price of gold.
Source – BullionVault
In August 2011, gold prices hit a high of US$1,900 an ounce. Five and half years later, they are at about US$1,237. A person who entered the market at its peak would have suffered a decline of 35% in principal value over the last half decade.
Risk of government intervention
Individuals are motivated to buy gold as it provides a safe haven for their money at times of economic and political crisis. Unfortunately, the high value of gold can tempt governments to take over private gold stocks.
Although it may seem quite unimaginable for a government to seize gold held by individual investors that is exactly what the US government did in 1933. At that time, Franklin D. Roosevelt, who had recently been elected as the country’s president, faced the Great Depression, which had resulted in a large slowdown in economic activity and an unemployment rate of 25%.
Soon after assuming office, FDR issued Executive Order 6102, a step that made gold ownership illegal in the country. The penalty for continuing to hold gold after the implementation of this order was harsh. Americans would face a fine of twice the amount of gold that they were apprehended with, in addition to a possible jail term of 10 years.
The government bought gold from the public at US$20.67 per ounce. Over the next year, the official price of gold was raised to US$35 per ounce.
Could a government take such a step today? While it is unlikely, the possibility cannot be ruled out.
Although gold should definitely form part of your portfolio, you should allocate only between 5% and 10% of the total amount available to you for investment to it. Any allocation greater than this has the potential to adversely affect your total returns.