Gold is Not an Investment

Today let's talk about a subject that seems to be touchy to some people specially those that are "investing in gold". Gold is not an investment. Now before you close the window and start sending hate mail, I suggest that you read the rest of the post. The basis of my statement is founded on the definition of an investment. An "investment” is defined as the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in the form of interest, income or appreciation of the value of the investment. Through this transfer of capital, in the expectation of a profit, an investor gives up capital and puts it at risk. The investor receives a return in dividends or interest as compensation because capital is at risk; investors may get back less than they invested, or they may get back nothing at all.

Gold does not qualify as an investment since it does not generate income by itself when we put our money and capital at risk to acquire it. Gold has no real intrinsic value, its value is the one assigned to it. I understand there is a market for gold, just like there is a market for real estate and stocks. Gold is raw material, it does not produce income, no dividends, no cash flow. Gold is a chunk of metal while a stock is ownership in a income generating company. The performance of a company can be tracked and projected, you cannot do so with gold. The price of gold is speculative. Commodities are regulated by offer and demand, the challenge for gold is that we do not know how much gold really exist therefore the price assigned is speculative, thus it is not an investment.

The problem I see is when people are putting assets at risk in the gold rush of 2010 thinking that they are investing. Investments are made by evaluating underlying value. Speculative bets are made by looking at the price of something and simply hoping the price goes up. Investing is about value; gambling is about price. In reality they are speculating. They are betting on how high the price of gold will go. There is no financial analysis to project the future income that gold will generate for you.

However, I do consider gold to be an important component of a financial portfolio. It can be used as hedge against inflation and a monetary collateral to sustain the value of currency. If you want hold some gold for diversification. In the unlikely event that paper currency becomes worthless some day gold and possibly silver would resume a role as a medium of exchange. Gold is money. Unlike investments, gold does not generate wealth, gold preserves wealth.

Right now, too many people are jumping on the gold bandwagon and really not asking why the price of gold is increasing. Gold’s main use has almost always been as money. However, gold’s secondary uses are growing in importance. Due to its physical characteristics, it’s a high-tech metal. So in todays technology driven society we are looking at gold beyond it main role of currency (gold is the most resistant to chemical reaction, the most ductile and the most malleable of all the elements, and it’s an exceptional electrical conductor), which in turn has increased its demand. Conclusion, increased demand drives the price of the commodity up. However, that does not change the fact that gold is raw material and by itself does not generate income. There is no certainty of the amount of gold reserves, which makes it hard (if not impossible) to determine how to properly price the commodity. Contrary to other commodities that gets consumed, gold does not get consumed therefore the more we extract the less valuable it becomes.

I would like to add a note here about real estate investing. Yes real estate is an investment. Real estate is worth what you can make from it, period. Rent it out and it brings income, live in it and it enables you to earn a living, grow food on it. The real estate debacle does not change the fact that it is an investment. The real estate bubble was caused by market distortions caused by idiots over the last ten years. But, the fact remains real estate is an investment and gold is not. Also, physical gold bullion locked in a vault, are not being invested; they are simply being stored. Therefore, while it is being stored they don’t earn interest or dividends, thus not an investment.

The reason of this posting is a warning to all of you that are considering "investing in gold". "Investing in gold" is a very dangerous game right now. Whenever the price of something rises as much, and as quickly, as gold has, we need to stop and consider the end game. As I drive through the streets of Florida, I notice the increase of guys standing on the streets waving “We Buy Gold” signs. They looked exactly like the guys I used to see all over Florida with the signs announcing open houses and selling real estate as a sure bet. The danger is how gold is being presented to the public as a sure bet investment. Due to the current conditions of the various financial markets locally and internationally, investors are looking where to place their liquidity to generate income. The problem is that there are a great amount of scammers wanting to take advantage of this opportunity to gain access to the available liquidity. Now please understand that I am not saying that you should not own gold, or that gold is a scam. What I am saying is that the people buying gold have no true way to value it, and therefore are speculating, not investing.

Finally, keep in mind that there are huge institutional players in the gold market right now. When they decide that the run is over, there won’t be time for you to run to your safe in the basement, pack up all your gold coins and bars, run to the local pawn shop and get rid of it. I do not know where the price of gold is going, but for me it doesn’t matter.