Confessions of a Money Manager: Gold isn't a glittering investment

Ray Unger  —  7/26/2008 5:04 pm

Have you heard those clever spiels on the radio coaxing us to buy gold in lieu of common stocks that can go to zero? Are they true? Yes, in a way. But sometimes the truth is mixed with a bit of chicanery.

Those gold ads remind me of a funny golf story. Ben Hogan is about to play an approach shot to a green fronted by a yawning pond. He asks his caddy what club he should use.

"I caddied for Sam Snead yesterday, and he hit an eight iron," quipped the caddy.

So Ben takes out his eight iron and smacks the ball right toward the pin as if it had eyes. But instead of coming down near the hole, it falls short and plops into the water. Ben turns, glares at his caddy and barks, "Are you sure Snead hit an eight iron?"

"Yup," quipped the caddy. "And he hit it in the water, too!"

Sometimes caddies, and as we'll soon discover, advertisers, leave out a few "minor" details when they tell us things.

First, let's talk about those common stocks that go to zero. Yes, some very high-profile companies have bitten the dust; Enron, WorldCom and a few others nose-dived when the tech bubble collapsed. But should we assume all common stocks have the potential to go to zero? That's like saying there are some dangerous people living in Madison -- we have had a few homicides recently -- so we'd better all pack our bags and get out of town.

Yes, common stock prices fluctuate, but those that go to zero are quite rare. In fact, investors who opt for owning an index like the Standard & Poor's 500 shouldn't be concerned with such possibilities. The way the S&P 500 is constructed mitigates these potential losses. The S&P 500 is composed of 500 large companies and is weighted by the market capitalization of each. The largest companies therefore represent the greatest share of the index. As such, when the failing companies fall in value they represent less of the index. When they hit that magic zero mark, their loss in the S&P 500 is quite minimal. Yes, the S&P 500 did lose when these companies went bankrupt, but the loss to the index holder was minor compared to those who owned the stocks outright.

Another claim in the ads is that the performance of gold far outpaced the stock market. Here again, that's quite true if we look only at the last eight years. The new millennial period began with the worst bear market since the Great Depression; from 2000 to 2002, the S&P 500 lost 38.6 percent of its value. It took from 2003 to 2006 for the S&P 500 to just recover from that steep loss. On the other hand, from January 2001 to the present, gold has been on a tear. It was under $300 an ounce back then and marched up to almost $1,000 earlier this month. As of Friday, it's about $927.

So should we jump into gold?

Before we do that, we need to understand a few basics about owning a metal. First, it doesn't pay any dividends. And unlike common stocks that currently don't pay dividends, gold will NEVER pay a dividend. That means investors in the shiny metal need to see prices rise to earn a positive return.

Second, the price of gold doesn't just go up. In fact, it can be quite volatile. Here is a link to a 30-year chart showing the price of gold supplied by Goldprice.org (goldprice.org/30-year-gold-price-history.html). As you can see, gold leaped in price from 1977 to 1980 only to fall back over the next 20 years.

In essence, gold is a speculation. It pays no dividends and its price gyrates wildly. If you compare the price of gold to the S&P 500 from 1980 onward, stocks won by a landslide. Even certificates of deposit beat gold. If you must own gold, at least buy a mutual fund like First Eagle Gold Fund (FEGOX $24.52). It pays dividends because it holds shares in gold mining companies that pay dividends.

Gold does have a glittering color, but as an investment, it's not that shiny.

Ray Unger is chairman of Forward Investment Advisors in Madison. He can be reached at 833-9400.

Ray Unger  —  7/26/2008 5:04 pm