Gold As An Investment

This article originally appeared on The Div-Net September, 8 2011.

This article is inspired by some of the posts I’ve seen lately around the blogosphere on the benefits and drawbacks of investing in gold. I’ve never really made my feelings on the shiny metal known on this blog before, so I thought I’d put it down in writing today. First off, I’m not a gold bug or a doomsayer. I’d like to consider myself a pretty level-headed guy, and in such I can see the pros and cons to owning gold. I don’t necessarily think it’s all-or-nothing. You can own many types of investments, and gold can be a part of your portfolio. That being said gold is very expensive at current prices, and price notwithstanding I dislike owning it for a number of different reasons. My thoughts on gold (and silver to a lesser degree) are as follows:

Why I like dividend growth stocks:

First, let’s discuss my motivation for owning dividend growth stocks (which comprise 100% of my portfolio as of today). I’m looking to retire young, hopefully before 40 years old. I define retirement by being financially independent and in a position where passive income meets/exceeds expenses. Dividend stocks pay me to own them. I can invest in a high-quality company like Johnson & Johnson by owning their common stock. In turn, Johnson & Johnson pays me a dividend, quarterly. I can use that dividend to pay expenses, or I can reinvest it. Because I can use those dividends to pay expenses, this investment is a viable approach to retiring young and achieving financial independence (from paid employment).

I look at dividend stocks like this: my portfolio is a fruit tree. My individual positions are branches on that fruit tree. From those branches hang fruit, which are the dividends. I pick the fruit quarterly, as that is the frequency most companies pay dividends. Every quarter I pick the fruit, and the next quarter new fruit grows. This process repeats itself many, many times (hopefully). If I were to sell the stocks by cutting the branches, I would no longer be able to pick that fruit (and pay my bills). That would be an undesirable situation, for many reasons. As long as the fruit grows and I pick it, my bills can be paid.

Why I don’t like gold:

Gold does not pay me dividends. In fact, not only does it not pay me to invest in it…but quite the opposite it requires me to pay out additional costs in the form of safe deposit boxes or other storage means in which to keep it safe. This, of course, is only true for the physical form of gold which is the only type I would own. Owning stock in mining companies or GLD doesn’t provide the tangible ownership of gold. Paper gold, like GLD, is simply tied to the market’s view on the value of gold. You could own GLD for the short-term fluctuations in the price of gold as a commodity, but I think if you are looking for a true long-term store of wealth the physical metal is the way to go.

Gold is one of the only investments, besides true cash, that doesn’t provide any type of cash flow. Stocks, bonds, real estate, CD’s and even bank accounts provide cash flow in return of an investment. Gold just sits there, and continues to shine. I can see the allure of gold, as holding it in your hand provides some type of mythical elation that has made it popular for thousands of years. But allure doesn’t pay my bills. Cash flow does. The only way you can receive cash for gold is when you sell it. Back to my fruit tree example, that is the least desirable option: selling your assets for cash. This would, in my opinion, be akin to buying an empty house as in inflation hedge/investment and then, instead of renting it for positive cash flow, storing it for years and eventually selling it because you need to raise cash. In addition to paying for the house, paying taxes/maintenance fees, and paying a premium to purchase it in the form of brokerage fees, you also paid taxes and fees to sell it. With gold, you pay a premium above spot to buy gold, pay maintenance fees to keep it (safe deposit box), and then pay taxes and additional fees to sell it. During your time of owning gold you received no cash flow. With dividend stocks I received my quarterly fruit, with which I can pay my bills. With real estate you can rent it out. You can’t rent out gold. 3 oz. of gold in a safe deposit box doesn’t pay my bills, but dividends do.

Another point that is rarely discussed: high-quality companies like Johnson & Johnson produce products that people need. It is because of this that they can continue to raise prices with inflation. This is, in itself, a hedge against inflation. With those rising prices come rising earnings and, in turn, rising dividends. These dividends usually outpace inflation by quite a few points. Gold doesn’t earn any money. It doesn’t produce anything. Its value is dictated completely by what people are willing to pay for it.

Why I would consider owning gold:

I would consider gold as a very small portion of my portfolio, generally much less than 5%. Once my portfolio crosses the $100k mark I wouldn’t mind owning 1-2 oz. of gold and increasing it by 1-2 oz. with every $100k. I would only own the physical metal, not stock. I want it in my hand, not a promise. The main reason, in my mind, for owning it would be as a hedge against some type of economic breakdown. For instance, the dollar collapses or the world economy has some type of major reset. Gold in this type of scenario could be invaluable as a bartering tool. Gold is a store of value: why this is I cannot explain. It’s along the same lines as 4-letter words being “bad”. Society sets its rules, and therefore it is what it is. Gold has value, and this will probably never change. You can use this to your advantage and have a small portion set aside just in case. I’m an eternal optimist, so I think the odds of actually needing physical precious metals highly unlikely. It is because of this, I’ll likely only own a very small portion of it, if any at all.

The opinions above are just my 2 cents (or 1/1000000 oz.).

What about you? Do you invest in gold?

Thanks for reading.

Comments

  1. Oculista says

    The big problem regarding gold is that nobody can argue what its price should be based on fundamentals. That is a big concern for value investors like me.

  2. Anonymous says

    I do not invest in gold in any form, as it has no intrinsic value and doesn’t provide cash flow (as you explained very well).

    I own 4000 shares of PM, which just increased their dividend 20.3%! These are the kinds of investments to own. :)

  3. says

    I think gold was a great investment 10 years ago. My parents allocated 50% of their portfolio into gold. They’re now retired millionaires. The other 50% were dividend stocks and bonds. I wonder what’s the next commodity everyone will be talking about 10 years from now. Maybe it’s natural gas or oil?

  4. says

    I have a similar position to you would consider on gold (portfolio around 600K, includes 10 oz of physical gold), and I see it in the same light; its a hedge against a major twist in the economy. I’ve thought about selling it at different points on the way up here, but I don’t see it decreasing in value in the short term, so my current plan is to use the gold and silver I own as a down payment for a home in the future when I’m ready (I currently rent).

  5. says

    Oculista,

    Great point. I didn’t address that. It is true that it has no fundamental value, but simply the value that society places on it as a commodity and store of value.

    Thanks for adding that!

  6. says

    Anonymous,

    Yep…it has no intrinsic value, which is very important, and the main reason I don’t invest in it.

    Great mention on PM. Getting a 20% raise for doing nothing but investing in a quality company is wonderful. I wrote an article on The Div-Net today about PM’s dividend raise. Getting a 20% raise, but not having to kiss up to my boss, stay late or come in early is wonderful.

    You have a huge position in PM. I don’t think I’ll ever have that kind of money in one position. I’m envious! It’ll take many years before I have a total portfolio value approaching the amount of money you have in PM. Keep up the great work!

  7. says

    MoneyCone,

    Great point! I don’t know if I’d totally dismiss it either, as I may one day have a very small position with physical gold…but that’s still a long time off. It does do well in times of uncertainty, which, I think, is why it’s done so well lately.

    Thanks for stopping by.

  8. says

    Henry,

    Well I’m betting part of my wealth that oil is going to be pretty strong over the next decade, since I was buying up Big Oil last summer and this summer as well. We’ll see how it goes.

    I’m glad to hear your parents did so well in gold. I love to hear of others’ success.

  9. says

    BigJ,

    Interesting that with the amount of wealth you have that you rent. I am also considering never buying, but it sounds like you’re ready to finally buy. It is a great time to purchase right now with real estate depressed. I think I may find myself in a position with a $300-400k portfolio in a decade or so and no real estate. We’ll see.

    Thanks for stopping by!

  10. says

    DM,

    I’m kind of in an interesting situation: I sort of fell into a lot of what I have, and all of the while I was a transient grad student/post grad now working in not the most stable job. So no, I’m not really ready to buy, and not sure if and when I will. I have to say, I’m watching all of my friends sign up for these homes with big mortgages, and even sitting here with the capital to actually pay for a great place, its not something I really desire. That being said, if the PMs I had in my portfolio rose to the point where I could actually purchase a place outright here (Boston area), then I would reconsider.

  11. says

    DM,
    Buy Gold in bulk and sell every month or sell on end of month and buy at the start of next to look at it from a cash flow perspective.
    Inq

  12. says

    Big J,

    I see what you mean. I guess that is interesting.

    My perspective is on retiring early and possibly traveling. If I’m tied down to a house it makes my goal of seeing different places and spending time with family difficult. It’s always possible to rent a place out, but that adds a dimension that I think I’d rather be without. Think “lifestyle design” or “geographical independence” and that’s kind of what I’m envisioning for myself later down the road. Of course if you have a wife and children, then buying is usually the right call.

    Thanks for sharing! I really appreciate it!

  13. says

    Inq,

    With that strategy you still do not have cash flow. You will be buying above spot and selling under spot…which is a losing battle. You will also trigger taxes if you make money. On top of all that, you still have to count on a guy down the road who’s going to pay more for the asset than you did.

    I wish you luck if that’s what you do though.

  14. Anonymous says

    I have 1 gold coin a krugerand that I bought in South Africa in 1985. I did have alot of silver that I bought in 90 & 91 I picked it up at $4-$4.50 range. I sold all of it at $37.07, I didn’t want to try & pick a top.Silver price was under the cost of production, so I knew my downside was limited, but I also knew that I might have a long wait before it hit my price target. It was a speculation pure & simple. I must disagree with you on GLD, if I were to take a buy on gold or silver I would go the ETF route as I’m not crazy about the 6% premium you will pay, also You will have to search carefull for an honest dealer I did.One last comment when I buy stocks bonds gold silver reits I don’t fall in love with them, they are not a wife just an asset, I don’t own them I’m not a partner in the company, I’m just renting them for a period in time, being a trend follower I buy price. There are trend followers like Larry Hite who are making serious money, in the millions.

  15. says

    DM,

    I have to say, so far I have done well with gold. I was buying gold bullion 5g ingot bars when gold was under $300 an ounce. I have 9oz. of physical gold. I also have about 60 troy oz. of American Silver Eagles that I bought at about $10 an ounce. It’s great to hold in your hand and look at the cool design of the coins and ingot bars. I’ve thought of selling it with the big run up in prices, but I’m just gonna keep holding it. Use it as a hedge against an economic meltdown.

    I have an off topic question for you. I was going to make a buy on an infrastructure play on Thursday with fresh capital, but unfortunately the stock jumped 1.5% on Wednesday and gaped up another 2% on the open on Thursday. So the stock ran away from me 3.5% before I could pull the trigger. I get perplexed in situations like this. I couldn’t pull the trigger and I guess I’m waiting on a pullback from it’s current price. I guess the risk is the stock doesn’t pull back and runs away from me. What would you do?

    Income Pirate

  16. Anonymous says

    Income Pirate, go ahead & pull the trigger, the market has already voted which direction the stock is headed. If your worried about the price increase of 3.5% then just buy less, like maybe 3.5%.

  17. says

    Anonymous,

    Great job on picking up gold at such a low price back then.

    I don’t really follow trends like that. Instead of renting stocks, I look at it like being a partner in a business. It’s a different way of investing, I suppose.

    Best of luck to you!

  18. says

    Inq,

    I apologize. I misread your statement to be a strategy you follow…not that there would be anything wrong with that. I see what you’re saying though. Thanks for the contribution.

    Take care. I appreciate it.

  19. says

    Pirate,

    I can see why you’d hold it as a hedge. I definitely can’t disagree with you in holding gold during these times…it’s a difficult marketplace right now.

    On your question, I look at it a couple different ways. First, I have about 50 stocks I monitor on a monthly basis and tend to concentrate on 4-5 right around time of purchase. I usually narrow it down to just a few so that I can accurately get a feel for when it’s an opportune time to make a move. If one of them pops too much before I get a chance to strike on it I would likely look at one of the other 3-4.

    On the other hand, I’m a long-term investor…and my preferred holding period is forever, if possible. So, if I purchase JNJ at $60 or $62 likely won’t matter 30 years from now. If I really like a company and feel it’s undervalued enough for me to purchase it, 3.5% doesn’t make a big difference to me.

    Just my .02. Good luck to you!

  20. says

    Dividends Warrior,

    Pretty nice collection there. That is one of the ironic beauties of owning physical gold…the intangible psychological effect of holding tangible metal in your hand.

    I agree 5% is a comfortable level for physical gold. I would probably not like to own any more than that.

    Thanks so much for sharing. Wonderful pictures!

  21. says

    I have a small position in gold, but it’s the physical kind rather than owning individual stocks or funds.

    The difficulty I have with increasing my overall portfolio exposure of gold to exceed levels of, say, 5% or 10% is because I don’t feel that it’s easy to forecast where it’s heading by any degree.

    Nice post DM!

  22. says

    TWC,

    Thanks for stopping by.

    I agree with you on both counts. I think you made a great move in your physical possession.

    I also agree that it’s hard to tell where the price action is going. As gold has no fundamental value or utility, its value is completely dictated by economic factors in the market that are very hard to predict.

    Good luck to you in your gold investment!

    Take care.

  23. Anonymous says

    [PART #2]

    Off topic:

    I’ve been talking about “legs”. The other legs I’ve found so far is: Buying/selling stuff (primarely cars, and seasonally affected boat engines), and yet another leg is to buy an excavator, which I’m currently saving up for (almost done!).

    With all these legs I don’t have to feel the preassure to quickly put my hard earned cash into a certain leg (like the stock market). So if we’ll see a REAL stock market crash I’ll just allocate more money to that leg (and so I migh buy a cheaper excavator, or none at all, for now). So whether or not the market crashes, I can feel comfortable that my average stock prices (and yield on cost), will be around decent to great either way.

    I think my YOC is around 7-8% since 2008. A lot to some, but barely worth it, for me (I have too small of a portfolio). That’s also why I need all those other legs, hoping that they will pay a higher “yield”, to make up for the low stock market dividends. I will buy during one or two more craches, to pick up more good yields.

    —–

    Well, that’s how I see things regarding metals, investments, and other “activities”. Anyone got comments? I’d love to hear some!

    Ohh, and two more things regarding gold/silver vs… :

    A) Bank accounts and most bonds don’t pay enough interest, to cover for the inflation – not even the official one, and certainly not after taxes. So in that regard something that is likely to keep up with inflation isn’t such a bad deal, is it?

    B) Who on earth pays taxes on their gold/silver profits?? ;-)

    PS. Yes I too find it strange that gold is always considered so valuable. (And silver should be worth more, especially these days where there exist more investment gold than investment silver).

    PS2. Yes, “longwinding” is my middle name!

    /T.J

  24. Anonymous says

    [PART #1]

    (I had to split my post, and they seem to appear backwards…)

    Hi!

    This is my first visit at your blog.

    I’m a quite amateour’ish little private “investor”, but I thought I’d share my views of gold/silver anyway:

    I’ve been trying to find various “legs” onto which to my investments shall lean.

    I started to buy dividend stocks (and some mutual funds, for the markets that are hard to access/control) during the fall of 2008. When the stock markets still kept falling I decided to read up a little. I thought I’d start with the basics, and asked myself “what is money?” – WOW, what a can of worms! And I quickly realized it’s essentially worthless (just smoke and mirrors since 1972).

    So as the markets kept falling I bought more stocks (for 2/3 of my assets), and also silver (1/3 of assets). Also a tiny bit of gold.

    I got the silver for the following reasons:

    1) Protection against (and making profit of) any turmoil or worldwide hyperinflation.

    2) This diversification gave me the courage to keep buying all that stock, and so “pays me dividends” indirectly, if the alternative would have been to buy less stock.

    3) It has no storage fees if you store it yourself (which seems to be the safest way, since you don’t have to worry about banksters and/or confiscation).

    4) And why worry about the premiums? You get it back when you sell! (Minus any cost for ads or Ebay, if you go that route)

    5) THIS IS IMPORTANT: In my country (which I’ll have to keep as a secret), we can buy various silver and gold coins, where their gold/silver value is very close to their official “legal tender value”. Buying such coins you can’t really loose much more than the consumer price inflation of the currency. And if the metal prices go down a lot, just sell the coins (or exchange them at the bank), and purchase gold/silver again, and now you’ve increased your holdings of “heavy metal” quite substantially.

    6) What if Mike Maloney at goldsilver.com and wealthcycles.com is right? I.E. that gold/silver will revalue itself against the currencies, as it has historically, while stock markets take a down turn (and then you should shift from metals to stocks and real estate). I’d like to take advantage of that, and then less than 5% allocation isn’t much! Doubling from 5% to just 10% will get you TWICE as much stock, if that scenario happens, while your stock portfolio will begin as only 5.3% smaller than if you had put 5% in gold/silver (1-0.90/0.95 = 0.053 = 5.3%)

    The idea is to not make any of my “legs” itty bitty compared to the other legs. If all legs can change in value signifficantly in the long run, I don’t want to put just 2% in a leg, since it won’t “save me” even if it increases well over an order of a magnitude, if all other legs does really bad.

    7) All of the above holds true for both gold and silver, but not for this seventh point: Silver has a real industrial demand, which is increasing, while its’ availability, both in inventories and in the earths crust, are getting depleted. So eventually we are likely to have a supply problem. Also, oil is probably getting more expensive too, and so does mining costs. Hence the price must go up.

  25. says

    Anonymous,

    Great additions there.

    I agree with you on a lot of your points. You should have multiple “legs” and be diversified. I completely agree with you. It’s a great idea to hold stocks, bonds, cash, real estate, precious metals..etc. I don’t think it’s a great idea to go 100% into anything. The only reason I’m 100% dividend stocks right now is because I’m still young and starting out and I think bonds are unattractive right now. I think gold/silver is very expensive since it has no fundamental value and although real estate is depressed and interest rates are low I don’t know if owning a home is fundamentally lined up with my ideas of freedom.

    I wish you the best with your investments and “legs”. It sounds like you have a great head on your shoulders!

    • Anonymous says

      “I think gold/silver is very expensive since it has no fundamental value”

      Fine if you believe it has no fundamental value, or is impossible to value… but, if you believe such, how can you possibly then declare it “very expensive”?? If YOU can’t value it, then you have no way to determine if it is expensive or cheap, right?

    • says

      Anonymous,

      I was actually wrong on my statement there. Gold has a fundamental value, if only for very light industrial use and jewelry. Beyond that, very little. So, it can be valued that way. However, when doing so it’s still extremely expensive. Silver has more use and so could be valued a little easier. However, it’s still impossible to truly value because it’s all subjective. Supply and demand have a lot to do with this, as that’s the main reason gold is much more expensive than silver. Both are used in jewelry, but a necklace with the same amount of silver against a necklace with the same amount of gold will be priced completely different simply because of the demand for gold. Does this really make sense? No.

      Best wishes.

  26. Onassis says

    Hi Jason,

    what do you think about: Freeport-McMoran Copper & Gold, Inc. (FCX)

    This company is not listed on the CCC-List. I don´t know why?

    The company have a big market cap (over 25 Mrd. EURO)
    The dividend payments are here: http://www.fcx.com/ir/dividends.htm
    The dividend ist not growing steady!

    My Question: Coud be this company a buy for your portfolio?
    And if not, why?

    Best regards
    Onassis

    • says

      Onassis,

      I’m not a huge fan of miners in general. I’m long BBL only because of the diverse operations in terms of products and geography. FCX is confined to copper and gold. Also, the dividend history is a bit spotty. I suspect that’s why they are not on the CCC list. For instance, they cut the dividend from $0.25 to $0.075 back in 2009. A dividend cut in itself isn’t reason to not invest, as I have investments in WFC and GE. However, without digging too deep I can imagine that operations are fairly cyclical as most miners are.

      Best wishes!

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