Should you invest in gold today? To better understand the place of gold in markets and the economy we have to go back and take a quick look at history. Gold has been around for longer than any currency, in fact, it was the first “currency” that ever existed, and its value depends on it’s scarcity and difficulty to get it. In ancient times gold was the currency used to trade, but due to it’s difficulty in storage and trade, later on, this changed, and institutions were made to store your gold and give you a certificate of deposit in exchange, these institutions are now called “Banks”.
The dollar was backed up for gold until 1971 when the president of United States Richard Nixon declared that dollar no longer would follow the gold standard, and thereafter the real value of the dollar is just a measure on the belief people have in it.
Understanding the Economic Cycles
There are 4 cycles in the economy: 1) Expansion. 2) Peak. 3) Recession. 4) Trough
Each Cycle is very complex, however, we are not going to go deep in each for the sake of this article. So here are the most important aspects you need to know about each cycle and what they mean, but before going into details you have to understand that the economic cycles are composed by two components, the Real GDP & Time:
Expansion: During expansion, the GDP of a country keeps growing as well as inflation. Also, stocks are in a bull market and unemployment rates are low, in other words, there is economic stimulation. Expansion is good but when the power of the FED is overused like is happening right now, it may cause a hyperinflation.
Peak: This is the Highest point of the economy and when it starts to slow down.
Recession: Also known as the contraction phase, in this phase economy starts to slow down, stocks are in a bear market and there is a deflation in the economy, consequently, there is less money available to transact.
Trough: This phase is the lowest level of the economy, after this phase the economy starts expanding again.
Below there is an illustration to help you understand better the Business Cycles:
What Is FIAT money?
“Paper money eventually returns to its intrinsic value = zero” – Voltaire
Well, FIAT money is a government-issued currency that is not backed by a physical commodity. In other words, in the US is the Dollar and in other countries it is their currency.
After reviewing the economic cycles and what happens on each stage, it wouldn’t be crazy to say that what we are currently experiencing is a hyperinflation, as trillions of dollars are being printed by the FED in order to sustain the market. You might think this excessive money printing is due to the current pandemic, well, it is not. The government has been printing money long before this global crisis started, and a situation like this is the perfect cover for them to keep doing so while submerging the country into an even larger debt. In other words, The FED is trapped, as raising rates will send interest expense soaring and many are starting to realize the long term implication for the value of the dollar and all currencies.
So What Actually is The Real Value of The Dollar?
As the old refrain says a picture is worth more than a thousand words. Below there is an illustration of the value of the dollar since the Federal Reserve was created in 1913:
The dollar has been losing it’s value over the years and if we compare what 1 dollar was worth in 1913 and today, you will be amazed how much money is represented in that time. Check it out here.
After reviewing all these facts and seeing how easy it is to create money for the FED we can really conclude that being in cash is not as “safe” as everyone thinks. So, does this mean that gold is the way to go and we should invest all of our money on it? Well, to figure that out we have to see the pros and cons of buying gold. In order to structure it better, I decided to make two simple questions and answering them with facts.
Why Should You Invest In Gold?
“Gold is Money, everything else is Credit.” – JP Morgan, 1912
To begin with a simple concept, gold is a very good decision for a portfolio diversification because it is somehow uncorrelated to other assets such as stocks or bonds and It’s always important to have a diversified portfolio in case anything happens with the economy. Another reason is that Gold as we mentioned before is limited, you cannot create it, so the supply growth is low espically when compared against unlimited paper money supply.
Therefore, is gold a good investment after all? Well, many good investors such as Warren Buffet don’t like gold because of the long-term returns gold has provided over the years, which is a good point after all, because if you compare gold against the stock market, gold has under-performed the stock market by a lot through history. However, other well known investors such as Ray Dalio really comply with the fact that we shouldn’t see gold as an investment but as a replacement of FIAT money or better yet as an insurance against any devaluation of money.
Interesting Fact: I wanted to point out the recent financial and economic news and say that Warren Buffet has finally decided to “buy” Gold in August 2020.
Why Should You Not Invest In Gold?
So now that we talked about the good aspects about buying gold, I think we should talk about some negative aspects about buying it because in AnnuityEdu we believe in unbiased advise, and the best way to really address anything in life is to see the good points and bad points and have an educated and objective point of view.
Among the disadvantages of buying gold, there is the well-known low returns that gold can give you for a long period of time, but as we pointed out before gold acts more like a cash reserve than as an investment vehicle. Also gold does not earn any dividends or interests, so don’t think if you invest in it, gold will give you any kind of passive income. Finally, when you buy any type of physical gold investments, it is taxed as a collectible, and gains on collectibles held for one year or less are taxed as ordinary income.
Can Gold work as a Hedge Against Inflation?
It would be unfair to give just an opinion on this matter since there are many factors that can affect the relationship between gold and Consumer Price Index. This is why I want to link you to one of the more recent and accepted studies related to this topic. Click Here!
But for what is worth, in many cases gold can be a hedge against inflation, however, it is not that simple. In a well-diversified portfolio that allocates a portion of it’s money to Gold, it is important to know how to reallocate the assets along with the different market cycles. For this reason, it is important that you ask a Certified Financial Planner in order for you to get a more comprehensive look at what a re-balancing can mean to your portfolio.
AnnuityEdu’s Take on Gold
After taking a deep look at what gold really is and what it means for the economy we think that gold can be an excellent replacement of cash, and in many situations, it is the core of a well-diversified portfolio. We don’t go with popular opinions, we always stick to the facts! However, it’s always important to run a retirement income analysis, in order to know what portion of your portfolio to allocate into any investment.
“Gold is a currency more similar to cash or a high-quality bond than it is a stock, but for some reason, it seemed to get compared to stocks often. Gold is not a business and cash is not a business either. Cash can be printed to infinity, Gold can not. Cash historically has been a receipt that you’ve had gold in the bank which highlights how gold is money and cash is more similar to a check that can potentially bounce. The rising gold prices rightfully so highlight investor fear of infinite paper money supply which I expect to accelerate in the coming years. There’s a generation of investors that have lost touch and don’t understand what money is. Due to this misunderstanding, Gold is extremely mispriced and undervalued.” -Andrew E. Carrillo CFP, AWMA, CRPC. Barnett Market Update April 13th,2020.