Last Updated Jan 25, 2011 8:43 PM EST
Behind the decline
Typically, gold does well when the dollar declines. Yet markets often make fools out of investors who rely on typical patterns. As weak as the dollar has been so far this year, gold has been weaker.
I could go on and on about why the experts think the price of gold has declined, but a much better explanation can be found in the financial equivalent of the law of gravity. What goes up must come down or, in this case, nothing can continue to go up at a high rate forever. That's true even for gold.
Cramer on gold
According to Jim Cramer, here's what you should do with gold:
"Trade gold as a short ... for an investment it's a long ... They can be two different things." Cramer went on to say that if he was at his hedge fund, he would be buying gold puts against his existing gold position, and then reversing that trade at the end of the month.Personally, I tend to take any advice from Cramer with a grain of salt, make that a block of salt. So I consider his advice on gold to be about as good as his prior advice about Bear Stearns not being in trouble. Yet it is a clear sign that certain investors are hedging their bets on gold's rise to $3,500.
Lessons from my past
This pull back of gold reminds me of the time back in 1980 when I bought gold for $664 an ounce after a pull back. Fresh out of college, and with great expectations, I bought the shiny metal. Instead of making a fortune, my investment didn't even keep up with inflation, a mistake I can now recognize in hindsight.
Assuming that gold will follow the same pattern as in the 1980's, would also be a mistake. And an even bigger mistake, would be to assume that paper currencies will go the way of the buffalo and we'll return to the gold standard.
Bubbles are hard to spot, but I do think these are signs of a gold bubble:
- People are sure of its constant future gains.
- People are telling me I "don't understand" the new paradigm.
- Solicitors are constantly calling me to request that I buy gold from them.
I happen to believe in gold and precious metals as a diversifier that often moves counter to stock markets. Unfortunately, most people buy it for the reason I did in 1980 - to get rich.
I happen to believe that the best way to invest in precious metals is through precious metals and mining stocks, which have far outpaced gold over the last three decades.
Two low cost diversified funds I like are the Van Eck Gold Miners ETF (GDX) and the Vanguard Precious Metals and Mining Fund (VGPMX). If you buy them, consider:
- That they are near their highs, with only a modest pullback.
- That they are extremely volatile and will make your stomach churn.
When, or if, you buy, always keep in mind who is selling. I've recently sold some as part of my rebalancing strategy.
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