The Role of Gold in an Investment Portfolio

August 5, 2009
Ed Rabinowitz

Is gold an investment with high purchasing power and the only true hedge against inflation, or a speculator's commodity with zero or negative expected return? Depends on who's answering the question. Financial experts give their take on gold's role in today's investment portfolios.

A century and a half after the infamous gold rush of 1849, the allure of gold has not diminished. Many analysts believe that gold should represent anywhere from 10 to 20 percent of an investment portfolio, if for no other reason than as a hedge against inflation.

“I don’t see gold as an investment, per se, as much as a hedge against the spending that’s taking place, and the very fragile nature of our economy,” says James DiGeorgia, publisher of the Gold and Energy Advisor and author of the book The New Bull Market in Gold. “We’ve created a debt bomb. And if you look at countries that have done what we have done, it always ends the same way. The currency collapses.”

Fear fuels desire

According to the World Gold Council, the biggest source of growth in demand for gold has been investment. Identifiable investment demand was up 248 percent during the first quarter of 2009 compared with the same period a year ago. Dan Deighan, founder and president of Deighan Financial Advisors, says that fear is driving the demand.

“People are very scared, and very fearful of what they see going on,” Deighan says. “They’re fearful of all the spending and all of the entitlement commitments coming out of Washington. Once you start to accumulate assets, and the closer you get in your financial life to depending on those assets for your income and lifestyle maintenance, the more fearful you become of losing what you have in the value of those assets.”

Deighan points to a payroll tax rate increasing from 15 percent to 23 percent and says that while the government may try to “spin it as an eight-percent increase,” it’s closer to a 50 percent increase. “But they don’t deliver it that way. And they’re selling it under the guise of having to fix the healthcare system. All of this is fueling people’s fear.” He adds that he’s very concerned about a currency devaluation. “And if our currency devalues, our stocks, our bonds, everything we own in paper is going to be valueless.”

A role for gold?DiGeorgia’s argument for gold is couched in history. He says that gold has been the only consistent form of currency for more than 5,000 years, and that it’s important to consider the value aspect. He suggests that in a deflationary environment, even if gold dropped from its current ballpark price of $922 an ounce, its buying power might still be double or triple what it would have purchased.

“You can buy a Ford, a new Chevy, or virtually any car and you’re going to pay about sixty- to seventy-percent of what you would have paid four years ago,” DiGeorgia says. “In that same time, gold has jumped from five-hundred dollars an ounce to virtually one-thousand dollars. So, you’ve had a forty-percent depreciation. It’s the same in real estate, and with many other goods and services. I think the facts demonstrate that the actual buying power of gold has increased far in excess of its rise the last few years.”

DiGeorgia adds that “I hope I’m completely wrong,” but he believes that the U.S. economy is in the early stages of a dollar devaluation that will first lead to a new record high in gold, and later, a monetary panic that will send gold upward to $2,500 and $5,000 an ounce. “Gold is really the only insurance you have against the politicians’ stupidity.”

Dissenters disagree

Michael Edesess, PhD, is the chief investment officer and partner of Fair Advisors, and author of The Big Investment Lie. He believes that gold does not have a role in an investment portfolio because it has a zero percent expected investment return. He says gold could have a role in the portfolios of gold merchants or speculators, the latter of which believe they can outguess the market price for gold. But that, he points out, is a speculators’ game, not an investors’ game.

“The idea that you diversify just by taking any old risk, even if it has a zero or negative expected return, is crazy,” Edesess says. “If you want an inflation hedge, you buy TIPS. They’re your inflation protected securities. They’re guaranteed to give you a return above inflation.”

Edesess suggests that if investors get specific about the risk they want to protect against, they will find a better strategy than investing in gold in each case. For example, he says that if you want to protect against a decline in the market, you simply buy less of it. Or, if you’re sure the market will decline, you don’t buy at all.

“But nobody has that kind of crystal ball,” Edesess points out. He explains that if investors purchase a diversified index, it’s likely to have some gold companies in it, so the strategy of investing in gold is covered. “Trying to come up with fancy strategies with the idea that they’re going to do something that straightforward strategies don’t do, people are just fooling themselves.”

Ed Rabinowitz is a veteran healthcare writer and reporter. He welcomes comments at edwardr@frontiernet.net.