Six Sound Reasons NOT to Buy Gold!

1. You Don’t Know How To Value It!
Is gold worth $500 or $3000 an ounce? Truth is, no one really knows. Most investments generate an income stream that can be measured as a percentage of cost. That percentage can be compared to other investments like Treasury bonds or considered as compensation for deferring use of your principal. People intuitively can understand spending $100 today versus waiting a year in order to enjoy $110. Unfortunately, gold produces no earnings or income.

Gold has no intrinsic value. You can’t eat, drink it, smoke it, or drive it. Its value is strictly based on perceived value by another – and that has proven very volatile over the years.

Oh sure, there have been attempts to put a value on gold. Some argue that an ounce is always equal to the price of a quality man’s suit. Some point to the average ratio of the price of gold to the level of the S&P 500 index as being 1.74 since 1980, therefore justifying a price of nearly $2,000.

Others target a price of nearly $2,287 by taking the all time high for the metal in 1980, $850 an ounce, and adjusting it for ensuing inflation. The math is clear, but whether the $850 price back then made any sense is another matter, as it lasted just briefly among panicky concerns about inflation, energy prices, and a Soviet invasion of Afghanistan.

On the other hand, some support for the price does come from the cost of production. That reportedly averages $556 per ounce. If gold were to decline toward that price, production would diminish, helping prop prices up but, if gold keeps climbing, that will spur production as previously unprofitable mines become profitable. The added production would tend to brake further price rises.

2. All The Gold That’s Ever Been Mined Sits as Inventory For Potential Resale
There is little in the way of actual use for gold; it does not get used up. While jewelry has historically been a use, it has been declining in importance since the 1990s as economies have soured and the price of gold has soared. In any event, much of the jewelry around the world is considered an economic asset, and could be traded or melted down at the right price and circumstances.

The bottom line is that nearly all the gold that’s been mined since the beginning of time remains and is potentially available for resale. That inventory is always increasing. As they say, gold is a commodity that’s extracted from one big hole in the ground, called a mine, and then redeposited in another big hole in the ground, called a vault. That supply overhang makes investing in gold quite risky.

The 1970s saw a huge run up in gold’s price. But, during the following two decades, it lost 80% of its value on an inflation adjusted basis. That potential still exists today.

3. You Don’t Know What Economic Conditions Lie Ahead and How They Will Affect Gold Demand
Gold is seen as a hedge against inflation and a weak U.S. dollar. The problem is, forecasting inflation is very tricky. Those who complain loudest about inflation argue that the Government’s fiscal policy has been too profligate and monetary policy too easy. For instance, the Federal Reserve recently suggested it would engage in further monetary easing should economic conditions deteriorate.

Betting on what policy makers will actually do is very difficult. They don’t want to see inflation or gold prices materially higher. The inevitable policy change to higher interest rates and higher taxes will dampen inflation potential and could cripple gold.

Next time you’re tempted to bet the farm on gold based on your economic forecast, heed Warren Buffett’s admonition that God put economists on the earth to make astrologers look respectable! Some of the same economists warning so vociferously today gave us no warning three years ago.

The bottom line is we know gold is trading at sharply elevated prices today. What we can’t be sure of is whether the dire economic forecasts driving that rise will materialize.

4. Even if it Makes Sense in the Long Term, Gold is Overbought Today
With the price of gold having tripled since 2004 and indeed having nearly doubled just since 2008, gold is on an unsustainable “J” curve. No amount of inflation or jewelry demand can justify its continuing up indefinitely.

The rise in gold is due to speculative demand, and can reverse itself quite quickly. The charts are reminiscent of the Internet bubble of the 1990s. Sure, gold may rise slowly to reflect inflation and gradual increases in extraction costs. However, the recent speculative demand is not sustainable, and carries grave risks.

Sentiment seems overdone, too. Television now regularly carries commercials offering gold. Numerous scams are being reported as unsophisticated investors rush to get involved. Gold is being touted as the cure all for whatever ails the economy. History proves over and over that when sentiment surges in a certain direction, a correction is often at hand.

5. Gold is Taxed Unfavorably
One of the attractions of stock investing [in the U.S.] is that long term Federal capital gains rates are capped at 15%. Unfortunately, gold does not receive similar favorable treatment. Gold is treated as a collectible, subject to a higher maximum tax rate of 28%. Investors do not escape the higher rate when they buy gold via gold bullion holding exchange traded funds (ETFs).

If you’re determined to invest in gold but wish to avoid those higher rates, consider gold mining company stocks. While they entail a panoply of risks that go beyond the yellow metal itself, at least your tax bill on long term gains will be less.

Another strategy is to invest using your IRA. Although collectibles like actual gold or gold coins are not permitted in IRAs, gold owning ETFs are considered acceptable. Gains in an IRA are not subject to tax until withdrawn.

6. Gold Produces No Income
Gold, like cash, pays no dividends or interest. That alone should make it suspect for those seeking income. What’s worse is that there is an opportunity cost for holding gold, namely, the foregone interest you would otherwise have generated from an alternative investment.

To make matters worse, proper safekeeping involves storage costs including insurance. Those costs are not avoided by buying gold via an ETF as the ETFs assess an ongoing fee, generally in the range of 0.4% annually, for those and other expenses.

In sum, gold at its current price is very hard to justify.

*http://www.gurufocus.com/news.php?id=108227 (David G. Dietze, JD, CFA, CFPTM is President and Chief Investment Strategist of Point View Financial Services, Inc. in Summit, NJ. He can be reached at [email protected])

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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