Last summer I wrote an article about speculators driving up the price of oil in the commodities market. Today, there seems to be a similar situation occurring in the gold arena. When you look to purchase gold, there are two reasons to consider buying it:

  1. On speculation that the price will go up, and you can sell at a profit.
  2. As a form of “insurance” or “safe haven” to immunize against the fear of a crises, such as an economic, political, social or currency-based event.

These are sound reasons to buy gold, yet they also reveal to us why gold is not truly an investment. The reasoning is that it is a store of value as opposed to a return on value; gold has no inherent growth and does not provide a stream of income or expected rate of return. It does not pay the holder interest, so instead of paying you while you wait for price appreciation, you must pay for gold to be stored and therefore has a negative cost of carry.

Stocks and bonds, on the other hand, are considered a true investment because they are regarded as a return on value, meaning there is an expectation of real price appreciation based on future growth of the underlying business and their earnings. Stocks and bonds have an inherent expected rate of return. In addition, some companies pay stockholders dividends as income. Bonds are also an income producing investment since bond holders are paid a coupon for lending money to a business and receive quarterly or semi-annual coupon payments in return. Such investments allow the holder to receive cash flow and potential price increases over the holding period of that investment.

Therefore, if the main reason to own gold is to speculate that the price will go higher OR to insure against an economic, political, social or currency based event, you must be clear about which of these two reasons most concerns you and why. You also must consider if there are better alternatives than gold to achieve your desired goal. Over the last 12 months, gold has gone from $750 an ounce to over $1,100 an ounce – a more than 45 percent gain in the last year. If you believe that it will continue on such a path, perhaps it would be logical to participate; however, price speculation also requires great timing to be profitable. Unfortunately for most people, buying low and selling high does not come naturally when participating in the financial markets.

On the other hand, if you are looking for a safe haven or insurance against a crisis, gold might be a good hedge. Currently, the price of this insurance is extremely high and perhaps there is an alternative way to hedge that risk at a lower cost.

As more and more people rush out to buy gold and drive the price to new highs, it is worrisome that this type of activity is drawing others to jump on the bandwagon. Whether or not gold continues to climb in price, we should all be very clear about the reasoning and logic used to make the decision to include gold in our investment portfolios.