Be Wary Of Fool's Gold

1/19/2010


To say gold has shined as an asset class would be an understatement. Since the beginning of 2007, the price of gold has risen 82%, versus a 20% decline in the S&P 500 Index. Factors driving gold prices include:

Inflation fears. With government spending and budget deficits skyrocketing, it is only a matter of time before inflation follows, say gold bulls. Because gold is seen as a store of value, it tends to rally on inflation fears.

Weak dollar. As the U.S. dollar declines relative to other currencies, investors holding dollars are more inclined to put their trust in gold.

Diversification. Increasingly, gold is seen as a core part of a broadly diversified portfolio.

Performance. Investors tend to buy the “hot” sectors, and gold’s gains over the last two years have fueled huge investor interest.

Can the gains in gold continue? Certainly. Gold pays no interest or dividends, nor does it represent an ownership stake in a company that could grow. So, it is tough to say when gold is overvalued. What does seem clear is that gold has become one of the more “crowded” trades in the market. Inflows into gold and other commodity exchange-traded funds doubled in 2009, and SPDR Gold Trust ($111; GLD) had the biggest inflows of any exchange-traded fund.

As for the reasons people are buying gold, the Forecasts doesn’t necessarily buy them. While inflation may eventually rear its ugly head, one of the drivers of inflation — upward wage pressure — is still missing. As for betting on a weak dollar, this also seems like a crowded trade. Regarding diversification, gold and stock prices have become increasingly linked over the past year.

As a hedge, a position of 5% or so in gold may make sense for some investors. But if you have loaded up your portfolio on gold and gold stocks, it may be time to take some profits.


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