Gold and Your Portfolio

Because these gold ETFs have proven so popular, most analysts (including this humble financial dude) believe this is of the four reasons that gold has rocketed up in price.

First, ETFs made it easier to buy gold. When things are easier, people do them more. This happened to gold. The ETFs are so easy to buy, more people are doing it.

Second, when there are uncertain times (think wars, financial crisis, terrorists), gold is seen as a safe harbor. Whether it is or not doesn’t matter, people think it is. So, if they get scared and don’t know what to do, they buy gold. Also, people look to gold and other commodities as a hedge in times of higher inflation and a weak dollar.

Third, India and China both are gold buying cultures. Very simplistically, in India, gold acts as a symbol of how good things are for you and your family. In China, gold has been used as an emergency fund for centuries. With both countries’ citizens prospering, their gold buying has increased substantially.

And fourth, gold has been skyrocketing because gold has been skyrocketing. When an investment goes up, people pile in thinking it will go up more. This rush of money makes the investment go up. More people pile in…and this keeps on going. It keeps going, that is, until everyone looks around, realizes that the investment isn’t as good as they thought it was, and stampede to the gates. Think of the tech bubble bursting in 2000.

India’s and China’s cultures are likely not to change, and gold ETFs will always be easy to buy, but our perception of uncertain times as well as the continuing skyrocketing of gold purchases is probably temporary. Because two of the reasons gold has gone up might stop, its value could drop, maybe even plummet. The other two should moderate this a bit, which is why I’m neutral on gold. I don’t see it as the end-all investment many do, but I don’t see it as a bubble that will burst and drive it back down below $1000 per ounce, either.

But like most predictions of the future, mine can be as wrong as anyone’s.

Fundamental to any strategy I use is diversification. By spreading your money across a variety of investments (the more dissimilar, the better) you are hedging your bets in case one of your “sure things” turns out not to be as sure as you hoped. Buying some gold can be a good diversifier. Buying nothing but gold is the antithesis of diversification.

People want to have all their money in whatever goes up the most. That’s understandable. What they don’t understand is that predicting what will go up the most is a fools’ game. Nobody knows. Everybody guesses. And sometimes, guesses are right. When a guess pans out, that doesn’t mean the person who made the prediction is brilliant, more often than not, it means the prediction was lucky.

But remember, I did say that buying some gold can be a good diversifier. So how much should “some” be? The consensus of the investment community is that a portfolio with around 5% of gold is good. They also tend to agree that funds that invest in gold, precious metals, and mining companies should be around 10% (though they are a bit biased in that recommendation). Theoretically, you could have 20-30% of your portfolio in gold and do okay financially. But most of you would vomit from the roller coaster ride that amount would take you on.

Gold: it’s sometimes loved (at times too much) and sometimes maligned as an investment (at extremes, unfairly). But gold is certainly appropriate for many portfolios if done in a reasonable way.

This article was published as part of a 3 part series in the Wichita Falls Times Record News on November 6, 2011 and November 13, 2011.