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Retirement made easy: Should I invest in gold?

Updated on August 18, 2011

Gold as a safeguard against inflation

Gold has investment markets running wild at the moment with the price of bullion seeming to set new records almost every week. That is prompting many investors and savers to wonder whether they should be investing in gold as a safeguard against inflation and as insurance against turmoil in financial markets.

The recent fascination with gold marks a huge turn from recent decades. Gold’s previous peak was almost 30 years ago, and for most of the time since its price has languished giving investors a poor return. Its revival has much to do with the re-emergence of two concerns in the global economy, inflation and turmoil that I’ll discuss in more detail.

A store of value over the ages

1933 double eagle gold coin
1933 double eagle gold coin

Why invest in gold

The main reason for gold’s rebound is the fear that inflation may emerge again. Rising prices were a blight on economies though the 1970s. Inflation was only contained by the Federal Reserve under Paul Volcker imposing such tight monetary policy in America that it caused a recession in the 1980s. Combined with credible inflation targeting in many other economies this ushered in decades of low inflation and stability that many economists have taken to calling “the great moderation”. This golden age was a great time to be an investor in almost any sort of asset from housing to stocks and even government bonds. The one asset that performed poorly was gold, partly because investors saw little need for it has a hedge against inflation that seemed to have been defeated. Many economists were calling it a relic of a barbarous age.

Yet in 2007, as the price of oil, food and other commodities surged it seemed that inflation might return from the dead. Those concerns have only been exacerbated since 2008 when central banks across the world slashed interest rates and started printing money to avoid a great depression. So far there are few signs of inflation, partly because the world economy has not yet recovered from its shock, but many economists have warned that prices will rise again once global economic growth returns to normal.

The second big reason for the rise in gold prices over the past few years is concern about the stability of the financial system and the security of other sorts of investments such as stocks and bonds. That worry is being stoked by turmoil in markets, instability of banks and the growing indebtedness of governments. Gold-bugs argue that whereas governments can default on debts, making their bonds and treasury bills worthless and that central banks can print money, making cash worth less, there is very little new gold being mined. In the technical jargon, gold is not correlated with other assets. In plain English, when the prices of stocks and bonds fall (or rise) gold does its own thing.

Why investing in gold is a bad idea

The case against owning gold is that it doesn’t yield anything. Cash on deposit or bonds all produce income but gold just sits there looking shiny until you need it.The fact that it is an uncorrelated asset is helpful but I suspect most people would be better off holding low volatility assets such as inflation-protected bonds (Tips or Linkers)The safety that some gold in your portfolio may offer has to be offset against the profit that might have been made by owning other assets. Looked at this way gold become rather expensive insurance for most people.

There is some evidence in portfolio theory studies that show how holding a small percentage of gold (5% of the portfolio) can give an overall benefit, but in truth the benefits are so small against a diversified portfolio that most people wouldn’t notice it in their private holdings (it is a different matter for big institutions where the difference in performance that a percent here or there gives them can mean the difference between being at the top of the league tables).

Private investors also need to weigh up all the other assets they own, such as a house, as well as their liabilities. In most cases a house and a mortgage provide plenty of protection against inflation (during times of high inflation prices of real assets, such as houses, should rise while the value of your mortgage stays the same – in other words in inflation-adjusted terms your mortgage gets smaller).

For that reason I won’t be investing in gold ETFs or similar gold funds in my retirement fund in coming years.


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    • Zee Candler profile image

      Zee Candler 7 years ago from Pittsburgh, PA

      Gold, silver, oil, ag. Forget the dang S&P index!

    • Jayne Lancer profile image

      Jayne Lancer 8 years ago from West London, UK

      I absolutely agree with you. There are so many better ways of investing money than in gold. I don't even buy 'real' jewellery for that reason, and my husband says it makes more sense to collect postage stamps than gold.

      Glad to see you're making people aware.