After last week's media frenzy, it is hard to blame investors for not coming down with a case of gold fever.
Newspapers, TV and the Internet were saturated with stories when gold broke the $1,300-per-ounce price barrier for the first time, sparking prognosticators to come out of the woodwork with predictions of even higher prices to come.
“Everybody asks about gold, because everyone in the media is talking about it,” Cindi Hill, founder of Hill Financial Advisors, said last week. “A client asked me just this morning about buying gold.”
Before clients jump in, however, they should know that the gold market rally is being driven more by fear than fundamentals.
And there is plenty of fear to go around, including:
• The threat of competitive currency devaluations.
• Chronic government deficits.
• Worries over sovereign defaults.
• The risk of another recession.
• An announcement in August by the Federal Reserve that it would engage in more-quantitative easing, which fanned fears of inflation and further weakness in the U.S. dollar.
Even assuming that the upward momentum in gold continues, and assuming an investor wants more exposure, advisers should urge patience in stocking up on the precious metal at these price levels.
Here are five reasons to exercise restraint:
1. YOU ARE LATE TO THE PARTY
During the decade since it hit its last bottom, gold has gone from about $250 an ounce to more than $1,300.
Although trends can stay in place longer than expected, there are signs that the gold market might be a bit bubbly.
“When I hear people at Starbucks talking about gold, it's time to sell,” Ms. Hill said.
She gave that exact advice to a client recently who had inherited a gold coin collection.
“Given everything that's happened, there's a perfect justification for gold to go up,” said Vahan Janjigian, chief investment officer at Greenwich Wealth Management LLC, which manages $650 million. “My concern, though, is that it's gone up way too much.”
Gold is overbought right now, said Brad Zigler, managing editor of hardassets investor.com. So if a client wanted to acquire the metal, waiting for a pullback might make sense, he said.
2. FUNDAMENTALS MAY NOT JUSTIFY PRICES
“There's no real demand for the metal for industrial purposes, and little for jewelry,” Mr. Janjigian said.
“Right now, what we've got going is a great big fear premium,” Mr. Zigler said. “If it wasn't for this fear premium, the price of gold may be closer to $850 an ounce,” based on fundamentals, he said.
Although gold recently hit a new high in dollar terms, it hasn't made a high in terms of other major currencies since this summer, Mr. Zigler said.
So the rally is “less about gold fundamentals and more of an anti-dollar” trade fueled by concerns over U.S. monetary policy, he said.
3. GOLD ISN'T A GOOD INFLATION HEDGE
A broad-based basket of commodities is much better in terms of inflation protection than gold, said Robert Arnott, chairman of Research Affiliates LLC, a developer of fundamental indexes and subadviser to several funds owned by Pacific Investment Management Co. LLC.
“I'm a big believer in inflation hedges,” he said, but “barring large geopolitical shocks ... gold is not the best inflation hedge.”
Gold is a good store of value in times of turmoil, but oil has been a better inflation hedge over the past two decades because oil prices have risen along with inflation, Mr. Zigler said.
4. GOLD WILL FIZZLE ONCE ECONOMY IMPROVES
“When the economy starts to recover, and when interest rates go up, the shine will be off,” said Edward Meir, a senior commodity metals analyst at the futures broker MF Global Inc., who nevertheless is bullish on gold for the next few years.
“When we get the next [gross domestic product] figures [that are] better than expected, and see jobs data that beat expectations, people will start questioning this idea that the economy will get worse forever,” Mr. Janjigian said.
That is when “there will be a rush to the exits,” Mr. Zigler said.
Gold is a “sterile asset,” he said. “It produces no income [and] costs money to store,” so investors will dump it once it stops rising.
5. CLIENTS MAY ALREADY OWN ENOUGH GOLD
Even die-hard bullion advocates recommend a relatively small allocation in individual portfolios — something like 5% to 10%, Mr. Zigler said.
Diversified portfolios of stocks and bonds might already have that level of exposure through gold-mining and related stocks.
“More of the mutual funds I own are doing more hedging with gold, like holding more mining companies, so [you may have] more than you know,” said Ms. Hill, who manages about $9 million for clients in addition to charging hourly fees as a financial planner.
Financial advisers who have been using gold as part of their allocation plan all along probably don't need any more.
“Gold has done so well, we're shaving back some of our positions,” said Randy Brunson, founder of Centurion Advisory Group, who allocates up to 30% of his clients' $45 million in assets into exchange-traded funds that track gold, water, base metals and oil.
E-mail Dan Jamieson at [email protected].
