4 strikes against gold

Why the yellow metal might not be as valuable as some investors believe.

By InvestorPlace Nov 2, 2010 11:51AM
By ETFguide.com

Exchange-traded funds in the gold market and gold stocks might not be as great as you've heard.

People are jumping on the gold bandwagon just like they jumped on the dot-com bandwagon and the real-estate bandwagon and every other bandwagon before them. Is this time different? Never mind gold's 20%-plus rise this year. It still has a lot of overlooked weaknesses as an asset class. Goldbugs won't like this, but here are just a few.

Strike 1: Produces No Income

What’s among America’s top financial problems? New findings from the Center for Retirement Research at Boston College give us a clue.

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CRR research shows a massive $6.6 trillion shortfall in retirement income. Contributing to this colossal problem are bank savings accounts, CDs, money market funds, corporate and government bonds all yielding a lot less than before because of rock-bottom interest rates. Simply put, Americans are strapped for income.

What about gold?

Unfortunately, investing in gold won’t help average working or retired people to fix their retirement income deficits. Why? That’s because a major drawback of gold is that it produces no income. And that’s bad news, especially if you buy gold at the wrong price and it ends up going down or going nowhere.

Should people with an inadequate income stream or an income problem be betting the house on gold? The answer is absolutely not. And even individuals with sufficient retirement income should probably do a double take before overstuffing their investment portfolios with gold.

Strike 2: Long Periods of Underperformance

Proponents of gold investing are quick to remind curious onlookers that gold has never been worth zero. And while this is an interesting argument it conveniently omits a few things.

First, just because gold has never been worth zero doesn’t mean it’s always been a good investment. In fact, there have been many long periods of time when gold’s performance was nothing short of awful. Are our memories that bad that we’ve already forgotten them? Let me help you remember.

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After reaching a record high of $850 per ounce in January 1980, gold prices fell over -40% in two months. And even then, the worst wasn’t over. It took gold 28 years to reclaim the $850 level. Will we see a repeat incident of gold’s historical head fake?

Today, the fact that gold has become such a popular trade should raise some red flags. The crowd is rarely right and if they are it’s usually short lived.

Strike 3: High Ownership Cost

Another overlooked facet of gold investing is the high ownership cost. If you’re considering making an investment in physical gold, don’t dismiss or ignore these significant expenses.

Acquiring physical gold in the form of coins or jewelry involves paying high transaction costs, commissions and possibly even sales tax. And then there’s the additional cost of insuring the gold and storing it in a safe location. All of these things reduce the gold investor’s return. Is the presumed “safety” of gold really worth all of these very real and very high costs?

Strike 4: Unfriendly Tax Treatment

Strike four against gold is its unfriendly tax treatment.

All gold and precious metals investments, including gold exchange traded funds and silver ETFs that take physical delivery are taxed by the Internal Revenue Service as collectibles, which is subject to a higher long-term capital gain rate of 28 percent versus securities. Under current tax law, most tax payers will pay a maximum long-term capital gain rate of either 5 or 15 percent depending on their income tax bracket.

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For this reason, some investors are opting for gold securities like miners, small cap miners or countries with heavy exposure to the mining sector like South Africa.

Incidentally, this year’s zero percent tax rate on long-term capital gains for individuals in the 10 percent or 15 percent marginal tax bracket applies to securities but does not apply to collectibles like gold or silver.

What and Whose Problems Is Gold Solving?

For the record, I’m not an anti-gold person. I happen to like it a lot, especially the way it looks on my wife.

However, gold fails to attack the crux of America’s financial problems. As mentioned earlier, inadequate income is a $6.6 trillion dollar problem for working people between ages 32-64.

And as an asset that produces zero income gold is the wrong answer for America’s income problems. (On the other hand, overheated gold sales definitely solves the income problem for gold hawkers, jewelry stores and coin dealers.)

This is not to say that gold does not deserve a place inside a diversified investment portfolio. It does. However, its place probably shouldn’t be as large as some investors are making it.

For more ETF research and ETF information, follow these links.

This article was written by ETFguide.com.

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