The Price of Gold and How To Invest In Gold

One of the questions many investors are asking right now is: Should I buy gold? With the price of gold near all time highs, it’s certainly a reasonable question to ask.  Before you start to look at gold as a way to make a killing, consider that the primary reason to own gold is for insurance.  Insurance?  Yes, let me explain.

The primary reason to own gold is that gold maintains its value during times of financial crisis.  These crisis’ includes political crisis, economic turmoil and the tendency of various Central Banks to print money in an attempt to “right the ship” after a credit expansion.

Whenever an economy accumulates excessive debt levels there is always bad investments called malinvestments in the economy.  This was the case in the recent housing bubble that has now since popped.  Central banks go out and “rescue” their member banks through a process called monetization, better known as printing money to try and re-stimulate the economy.  This only devalues the currency.  Not only are creditors paid back in devalued currency, people’s wages and savings are worth less.  This is often referred to as inflation.

Today in 2010, we have recently lived through what can be called the largest credit/debt boom in modern history.  When the credit boom comes to an end as it clearly has, Central Banks have 2 options: to let the debt deflate or attempt to keep the boom going by lending to member banks at excessively low (near 0%) low rates.  Clearly, the Central Banks have opted for the later scenario.  The only problem though is that most consumers are now trying to repair their individual balance sheets.   Expecting consumers to refinance during record foreclosures and bankruptcies becomes like “pushing on a string.”

As consumers and businesses tend to pull away from refinancing, the potential for currency devaluation only rises.  This is what happened in Iceland and more recently Greece.  At some point, the probability of rising interest rates comes into play and things once considered “safe investments” are at risk for losing value suddenly.  Imagine holding a 10 year U.S Treasury that suddenly loses 15%.

Owning gold helps insure you against these scenarios: inflation and deflating bond prices.  And, while there are no guarantees, at least when you own gold you don’t have to worry about your counter party defaulting on it’s promise to pay you back.

Just to be clear, I am not suggesting that you go out and start buying gold at once.  Simply consider how allocating 5-10% of your portfolio to gold bullion or investments like gold coins can hedge or insure your portfolio against the kinds of uncertainty mentioned above.