The Case for and Against Gold
Buy Gold: It's a Safe Haven and Inflation Hedge

By JANET BRIAUD
March 14, 2011
Wall Street Journal

Should gold be represented in an investment portfolio? I believe it should, for a number of reasons.

In the short run, gold can be a safe haven in a time of crisis. We don't know what the next crisis will be, but we have seen plenty of "black swan" events over the past two years alone; our markets and our world seem increasingly hard-wired to experience periods of crisis and calm. In this sense, gold can be seen as a short-term hedge, or a short-term speculative play on volatility.

Some may say that we're heading for a period of stability, but that's hard to believe. The Fed is desperately trying to stimulate the economy. Housing prices remain weak. Unemployment remains high. On the political side, the Middle East has been far from stable in recent weeks. We have learned from the past three years that events can move extremely quickly in our increasingly interconnected world. Stability will be more and more fleeting—perhaps permanently.

In the longer term, gold is a good way to invest in expectation of higher inflation—a growing possibility. As governments battle debt problems and central banks intervene on their behalf, we could very well see deliberate weakening of currencies in many developed countries. Why use gold, rather than some other inflation hedge? Simplicity. Gold can be easily held in most portfolios, particularly with the advent of gold-bullion ETFs.

Another consideration for the long term is that gold may partially regain its status as a reserve currency. Individual investors hedging against inflation with gold is one thing, but central banks doing the same is another matter entirely.

If central banks start buying gold in earnest, it will create extra demand. Even if central banks simply hold onto their stockpiles of the metal, they will limit supply. Either scenario gives some support to the gold price.

The reasons for owning gold are not all pessimistic, however. Unprecedented numbers of people are entering the middle class across the globe. As these newly minted members of the middle class continue to save, they will continue to be a growing source of demand for gold—even if gold jewelry starts losing its luster in the U.S. This is actually the reason I started investing in gold for clients back in 2003.

Some may not agree philosophically with the value we place on gold, a metal with few industrial applications that produces no income. But, like anything, its price is determined by supply and demand. Supply has always been limited, and demand has always been high.

Valuable in All Cultures

Throughout history, gold has been valuable to humans of all cultures. Consider how the Spanish conquistadors encountered cultures that also treasured gold. These were two independent civilizations, on what then were completely opposite ends of the Earth, yet both valued this same shiny yellow metal.

In other words, gold was treasured long before the invention of stocks, bonds, fiat currencies, credit default swaps, collateralized debt obligations and the like. When part of a portfolio of income-producing assets, gold gives some protection against that income being eroded by inflation.

Naysayers raise questions about the ethics of owning gold, but debating the ethics of one type of economic activity over another will rarely yield satisfactory answers for everyone. Is mining exploitative to the people in the mines? To the environment? Does it bring prosperity to the producing countries? Or does it foster corruption and poorly diversified economies? These questions have been asked about nearly every product imported into the U.S. If we set our sights on gold for this scrutiny, we should do the same for other products.

To be sure, gold comes with caveats, and investors should incorporate it into their portfolios only with an understanding of the risks. It can be volatile, for one thing, and prices certainly look more frothy than they did a decade ago.

But they're far from bubble territory. Gold, which is currently above $1,400 an ounce, would need to top $2,000 to match its all-time high, adjusted for inflation. Indeed, gold is still something of a contrarian investment. Ten years ago, gold was almost universally hated as an investment. I know firsthand because people thought I was crazy for buying it. Today, gold is still eyed with suspicion by most.

For instance, the GLD exchange-traded fund holds over $53 billion in its vaults; that may sound like a lot, but it is less than 0.1% of the financial assets owned by households and non-financial businesses in the U.S.

It's also true that you may pay a markup for buying gold; the cost of buying a security should be factored in any investment decision. However, there are plenty of popular vehicles that, in my view, charge reasonable prices for exposure to gold: GLD, for instance, costs 40 basis points annually.

Another complaint is that some ways of buying gold come with extra risks. I agree that investors should take those risks into consideration. Gold-mining shares, for one, are definitely more volatile and can be correlated with the stock market especially in sharp declines—so buyer beware.

As for the argument that gold will make lower returns than an investment with dividends and interest—that's simply not knowable. If we look at the past 11 years, the S&P 500, which has dividends, has delivered no returns.

A Modest Allocation

I do not advocate an enormous percentage allocation to gold, but I do think a responsible investor should allocate at least a portion of the portfolio (5% to 10%) to the metal.

In the near term, it offers some protection from the next "Black Swan" event. More long term, it offers a hedge against the threat of inflation. In the meantime, it offers a unique way to invest in the prosperity spreading to the billions who inhabit South and East Asia. These reasons are every bit as applicable now as they were 10 years ago, when gold was worth a quarter of what it is today.

Ms. Briaud is a certified financial planner and a partner at Briaud Financial Advisors in Bryan, Texas. She can be reached at reports@wsj.com.

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