MakinSense Of Two Things You Need To Know If You Own Gold

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Updated: April 13, 2013

Gold fell almost five percent last week. It’s now down about 20 percent since its peak in August 2011.

Most people have exposure to gold through a gold fund that trades like a stock called “SPDR Gold Shares.” This is the most common Gold ETF (exchange traded fund).

If you work with a financial advisor I’d bet this is what you own. No clue what I’m talking about? (totally normal, see my site tag line), sign up for my investor class, here.

The three main reasons why everyone is freaking out and selling gold, are:

    1. Goldman Sachs put out a research note saying they think the value of gold is going to decline. (I’m ignoring this research. Remember they also told us to buy small cap stocks after stock market volatility goes down. I explained why that makes no sense, here.)
    2. People buy gold as a hedge to rising prices. As prices rise, the value of your money goes down (here’s a video explainer of inflation). In short, one dollar will buy you less of whatever you’re buying as prices rise. Most of the time but not always, “hard assets,” like gold, hold their value when prices rise, so people buy gold as a hedge to rising prices. But, inflation numbers that came out last week were low, so people feel less of a need to “hedge” inflation so they’re selling gold.
    3. Cyprus might have to sell some of their gold to help raise money so their country doesn’t go bankrupt. Missed what’s going on in Cyprus? Here’s a seven picture explainer.

What You Need To Know, Two Things:

The last two points are what you need to think about. Both of those points trigger a sell-off in gold, but for very different reasons:

  • Point #2 has to do with the US economy and people believing that inflation is going to be low for a while. In other words, they don’t see prices rising any time soon. So, they need less exposure to gold (since gold is a hedge to rising prices).

If you’re in this camp, this is the reason people are using to *sell* gold. They don’t want to catch a falling knife. 

  • Point #3 has to do with a liquidity crisis. Cyprus needs money, so, they’re talking about selling some of their gold to raise some cash. This could encourage other European countries to do the same. Other countries don’t want to own too much gold if it could decline in value quickly.

If you’re in this camp, point #3, this is the reason US investors are using to *buy* gold after this big sell-off. This is assuming you’re of the belief that inflation *is* an issue, or will be an issue, so it’s a good time to buy a gold fund on the cheap.

Selling gold to raise revenue in a liquidity crisis, point #3, like what Cyprus is going through, is totally unrelated to point #2. Both can cause gold to decline in value, but for different time frames and completely different reasons.


Image via Rich Kids of Instagram

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One Comment

  1. scott

    April 15, 2013 at 2:32 pm

    gold is notoriously volatile. there have been a bunch of 25% – 40% corrections through the whole Gold Bull Market we’ve had for 12+ years. It just comes with the territory. I would simplify the reason to own it.

    If you believe the Federal Reserve and Japan printing billions of $ and yen every month is irresponsible and inflationary, you should hold gold.

    If you think it’s ok that the Fed and Bank of Japan are doing this and doesn’t have long term consequences, then it’s a good reason to sell gold.

    It’s really that simple. Jim Grant always says that buying Gold is a vote against central banks. I think that is a good way to think about it.

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