Investing in gold
April 02, 2004
In response to last week’s column, Don wrote
to say that terrorism’s influence on the gold price does not
make the metal a bad investment choice. He makes the point that
the biggest increase in the gold price occurred during 1979 and
early 1980, mostly due to tension between the United States and
the Middle East, exemplified by the Iranian Hostage Crisis: a terrorist
act. Don then asks, rhetorically, why that would not have been a
good time to invest in gold.
He goes on the say that people turn to gold during
times of political instability and uncertainty, and that the success
of the terrorist act in Spain (in changing the political climate
there) indicates that we are likely to experience more such atrocities.
Given that terrorism will continue to influence gold’s future,
the prospect of increased terrorist activity is a sound basis for
investment.
I agree with Don almost entirely. History confirms
that people tend to buy gold during times of trouble and uncertainty.
The situation today is quite analogous to the late seventies. There
is tension between the United States and Muslim countries and as
far as terrorism goes, things are likely to get worse before they
get better. It is also true that a lot of money could have been
made buying gold during the late 1970s. But, and this is where I
disagree with Don, buying gold in anticipation of increased terrorism,
or the threat of continued political and social uncertainty, is
not a good investment idea.
Predicting the timing and severity of terrorist activity
is nearly impossible. Even if we are certain that terrorism will
increase, we don’t know whether there will be a major strike
this year, or next. Perhaps nothing will happen for three years.
Or maybe there will be a spate of activity later this year, and
then a lull. Either way, most people are likely to feel the urge
to buy gold when there is an increase in terrorist activity, or
uncertainty, or both, precisely when gold will be trading at higher
levels.
Similarly, they are most likely to sell their gold
when peace and calm prevail, since they would no longer feel compelled
to own a non-income-producing metal; precisely when gold is trading
at lower prices. That is why most people tend to lose money on their
gold “investments”.
To state the obvious, you have to buy when the price
is low and sell when the price is high. For gold that means you
buy it during times of peace and calm, when the threat of terrorism
seems remote and the price is relatively low. You should sell gold
when there is turmoil and the price is high. After all, if you bought
gold as an investment, you intended to make a profit.
So while I agree completely with Don that the probability
of increased terrorist activity is high and that the gold price
could rise as a result, the unpredictability of terrorism and human
nature do not make increased terrorist activity a sound basis for
investing. Buying gold in anticipation of terrorism could, however,
be an excellent speculation. Also, gold is a superb form of insurance
against increasing political and social turmoil. The difference
is psychology, not semantics.
Investing requires a high degree of certainty in the
worth and timing of your expected return, with a clear understanding
of the risks attached. Good investments can often be held for long
periods of time, with relatively low risk, and a fairly certain
return on capital. Buying gold on the basis of increased terrorist
activity, even if it occurs and you make money, does not qualify
as an investment. It is pure gambling because predicting the extent
of paranoia, and hence the extent of the increase in the gold price,
is not possible. At best you could only have a low level of confidence
in the outcome and timing of your return. And if you bought gold
in anticipation of increased terrorist activity and such activity
does not materialize in the short term, what do you do?
Gold is, however, an excellent form of insurance.
But, as with any insurance policy, you are always better off if
you do not have to collect on it. The psychology of buying gold
as insurance is very different from buying gold as an investment.
There is no profit motive and it makes sense to buy gold during
times of increased terrorist activity, which is what the public
tends to do. If you end up buying gold at elevated prices because
of an increase in uncertainty, or as in our present case, an increase
in terrorist activity, you can logically justify the decision because
you are merely buying insurance during times of turmoil at a higher
premium. But then don’t turn around and feel blue if the gold
price declines when things calm down. If you didn’t need to
cash in your gold to stay alive, or to take care of other needs,
you should be thankful. It was an insurance policy that, at the
end of the day, you did not need.
People speculate (gamble) on just about anything --
gold is no exception. Astute speculators, like successful gamblers,
understand their game intimately. A speculator’s gold market
is very different from an investor’s, or someone buying gold
for insurance.
A speculator might buy gold on the assumption that
terrorism is on the rise and therefore the gold price is likely
to do well. Don’t, however, confuse that with investing. A
true speculator will know when to cut his losses or ride a winning
streak much better than someone who is under the impression that
he is investing when in reality he is gambling.
Whether you buy gold as an investor, for insurance,
or as a speculation does not matter. But in order to profit you
must know into which category you fall, and be very clear about
your own strategy and psychology.
As an aside, if you’re curious how much
the war in Iraq is costing the United States, take a look at www.costofwar.com.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
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