Gold Prices Got You Down?

Last week gold prices dropped 15% in two days. This was the largest drop in 30 years, and created widespread panic on Wall Street.

Hedge funds and traders who were betting on the rise of gold prices via futures and the gold ETF found themselves having to unwind their positions in a hurry. The ensuing panic selling probably fueled the downward decline.

All over the news, the pundits came out saying that the bull market in gold is now over.

Several investors called in, quite concerned about what was happening and what they were reading in the media. After all, a couple of our portfolios hold a small allocation to gold.

So, should you panic about the collapse of gold?

First of all, consider why do we own gold?

I like to think of gold as a form of insurance. As one of my friends’ likes to call it, a chaos hedge – for when things get really bad. 

Historically, gold has provides a long term hedge against  monetary mismanagement. That’s one of the reasons why it’s price has been increasing for 12 years. As the Federal Reserve and the European Central Banks keep printing more money to solve their countries financial problems, gold prices have risen every single year for a dozen years.

You can’t expect an asset class to go up without taking a break now and then.

Besides, as confidence in the economy improves and the stock market keeps hitting new all-time highs, gold prices can and will take a backseat.

So if we know that gold prices are going to lag stock returns, should we  sell it in favor of stocks?

No.

Mainly because no one can predict the future.

Also, academic research has shown that even if the expected real return of an asset class is zero, when added to a diversified portfolio and coupled with regular rebalancing, it will improve the overall returns and reduce volatility. In plain English, this means that even if the long-term price of an asset is unlikely to beat inflation, it can increase your returns and reduce the sharp declines in your portfolio.

Besides, the panic selling seems to be driven by the futures market – the domain of speculators and Wall-street traders. There have been reports from Dubai, India, China and Bangkok about a shortage for physical gold. People who actually buy gold are jumping over themselves to use this pull-back to buy more.

In the short-term prices may fluctuate wildly, but unless you’re short-term speculator on margin, you should be fine.

So, as usual, my recommendation is to keep calm. There’s always something to worry about in the investment world. But unless, you’re in Cypress and all your wealth is in the bank, you shouldn’t have anything to worry about.

The Cypress reference is about a retiree who worked for 35 years in Australia and moved back to Cypress with $1 million that he deposited in the bank. When the Cypress bank folded last month, he lost nearly all his life’s savings. Maybe this is why people are still buying physical gold?