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Gold: The Worst Investment Today?

By Jacob Wolinsky   |   Thursday, 13 Dec 2012 07:39 AM

With the year ending, pundits are looking at what performed well in 2012, and what they expect to be a good investment in 2013. Most of these predictions are bad, but that is a topic for next week.

One investment in particular stands out as needing some clarification — gold. The precious metal is up approximately 8 percent this year, according to the latest data. Gold is becoming an increasingly popular investment especially in the Austrian/libertarian schools of thought. Additionally, many investors who lean more toward the Keynesian school are also buying gold.

Investors such as Warren Buffett do not consider gold to be an investment. Buffett likely believes this because he lived most of his life under the gold standard, when the price was fixed. However, many famous investors disagree with Buffett’s reasoning.

I will assume Buffett is wrong, but still urge caution for the reasons below.

The rationale for buying gold is usually somewhere along the following line: Central banks are printing money in an effort to cause inflation, devalue currencies to strengthen exports and inflate asset prices. This makes gold a good investment because it is a hedge against inflation and a declining currency as well as for investors who do not want to earn zero percent in the bank.

The theory is very sound, but it has one big problem and this is the key — everyone has the same exact argument for gold. From the letters of the biggest hedge fund managers to posts on smallest blogs, there are millions of people writing about why gold is a great buy. Nearly every single argument uses the above reasoning in a nearly identical form.

There are other arguments for buying gold, such as having the precious metal if there is a complete collapse of civilization. However, the central bank printing reasoning is the overwhelming reason most investors use to justify the investment.

Why does this make gold a bad investment? Financial markets are largely efficient mechanisms. When there is news concerning geopolitics, companies or anything relevant to any type of investment, the price of oil, stocks and other instruments move instantly. The market is not always efficient, but it is most of the time.

I would argue that when everyone is buying gold for the same reason, the market has already incorporated the thesis into the price of gold. When the United States started running big deficits in 2000, an ounce of gold cost approximately $270. Today, the price has jumped to over $1,700 an ounce. Since the first round of quantitative easing in 2008, the price of gold has doubled.

The market saw the dollar decreasing and the Federal Reserve printing money over this time period and it was largely incorporated into the price of gold bullion. Investors expect the Fed and other central banks to print more money, so gold will not jump if that changes.

It is impossible to say with certainty what gold prices will be in the future, but it seems that investors using the argument in this article are very late to the game.

Disclosure: The author of this article has no position in gold.

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