Should You Buy Gold Now?

In this undated handout photo from Newmont Mining Corporation, gold nuggets and bars are shown. The price of gold rose to a fresh 25-year high as investors sought a safe haven amid a weakening U.S. dollar and worries over the West's confrontation with Iran. AP Photo/Newmont Mining

This story, by James Picerno, originally appeared on CBS' Moneywatch.com

It had to happen. After the gold prices broke record after record and the metal reached $1,200 an ounce, it fell hard, sinking by 4 percent in a single day. Some smart observers, including MoneyWatch Editor-in-Chief Eric Schurenberg, think gold is too expensive for you to be a buyer now.

So, is it too late to get in? And if you own gold, is your investment headed for the cellar? No one knows for sure, of course, but the bullish case remains compelling. Even at more than $1,000 an ounce, gold's charms are still alluring - albeit less than they were in May, when MoneyWatch offered a primer on investing in gold and the price was about $925. Although goldbug and financial analyst Jim Grant has turned lukewarm on the metal, he recently told his newsletter readers that he guesses "the move has further to run." Commodities bull Jim Rogers told BusinessWeek that he expects gold to "," probably after a correction.

But given the run-up of 2009 and the likelihood of a bumpy road ahead, it has become even more important to know how to invest wisely and avoid paying excessive fees for gold securities or the actual metal.

The Case Against Gold

It's easy to argue against investing in gold today. For one thing, an asset that soared more than 30 percent in a year, has had nine straight years of gains, and just lost 4 percent of its value in a day should give you pause. For another, economic turmoil tends to boost gold's fortunes, and a degree of stability has returned to the global economy. Plus, gold is often considered an inflation hedge - indeed, fear of inflation has helped power gold's recent run - but inflation is virtually nonexistent. The Fed is more worried about deflation these days.

The Case for Gold

But five trends - rational and otherwise - suggest that gold has room to run:

The dollar is falling. "People aren't necessarily worried about inflation pressures," says Stephen Platt, a commodity analyst at Archer Financial Services in Chicago. "They're more worried about the devaluation of the dollar." Historically, gold has been the asset of choice for people who lose faith in their currency, and gold and the greenback have had a seesaw relationship since the 1970s, when currency prices were first allowed to float. When one rises in value, the other tends to fall. Owning gold is increasingly seen as a hedge against the hazards that come with holding the dollar, the world's reserve currency.

Central banks in emerging nations are buying. The central banks of India, China, and other developing nations have been purchasing huge quantities of gold, in part to diversify against the dollar. Recently, the Reserve Bank of India bought 200 metric tons worth $6.7 billion from the International Monetary Fund. Shortly after India's announcement, the central banks of Sri Lanka and Mauritius reportedly bought the metal, albeit on a far smaller scale. Grant notes that while central bank holdings of gold are hefty in the U.S. and much of Europe, the metal still represents a small slice of official reserves in Asia. "China is the sixth-largest official owner in the world, with just over 1,000 metric tons, but that sizable hoard amounts to less than 2 percent of total reserve assets," he notes in the latest issue of Grant's Interest Rate Observer. Ji Xiaonan, an official at China's State-Owned Assets Supervision and Administration Commission, recently said that "though it's not known how much the Dubai crisis will affect the global and domestic economy ... this may give China an investment opportunity to use part of its foreign reserves to buy gold and oil reserves." If emerging nations boost their gold holdings to, say, 10 to 25 percent of reserves, Grant says the change "would represent a tremendous amount of demand."

Dollars are sloshing around the global economy. The world is swimming in monetary stimulus, because central banks reacted to the financial crisis by aggressively printing money. Gold is responding to the eased monetary policies with higher prices, says Martin Murenbeeld, chief economist at Inflation will return someday. Murenbeeld, like many other economists, believes the liquidity surge from today's easy monetary policies will almost certainly lead to higher inflation. David Levenstein, a precious-metals analyst at Lakeshore Trading in Johannesburg, South Africa, predicts that "when we see inflation kick in as a consequence of the huge stimulus programs and massive escalating deficits, gold will soar even higher." • Individuals and institutional investors are chasing the momentum. They don't want to be on the sidelines when it looks like everyone else is a buyer. The SPDR Gold Trust (GLD), the world's biggest gold-bullion-owning ETF, recently held nearly 1,130 tons of the shiny stuff, up by 40 percent this year. That's a bigger stockpile than the gold reserves for all but five nations. Here's what's new: Financial advisers are now including gold as a part of smart asset allocation, says Murenbeeld. Maybe that's only because it's been rising, but it could represent a significant development. If all investors, not just those who think the world might end in 2012, start allocating even a tiny share of their portfolio to gold, that could put a tailwind behind the ETF. Americans are going nuts for U.S. gold coins, too. The U.S. Mint has sold 1.13 million 1-ounce American Eagles this year, 31 percent more than in 2008. Consumer demand to store gold is so strong that storage space has become scarce. Some retail investors were recently told to move their hoard out of HSBC's Manhattan vaults so the bank could better service institutions, according to The Wall Street Journal.

MoneyWatch.com Video: Why Gold Prices Are Sky High

How to Buy Gold Now

Many financial advisers recommend keeping roughly 2 to 5 percent of your portfolio in gold as a form of insurance to diversify your portfolio, perhaps as part of a broader commodities position. No need to buy it all at once. Since gold's price will surely hit some dips, even if it trends higher, build a position by dollar cost averaging over a year or longer. This will ensure that you'll buy more gold when the price falls and less when it rises.

The three best ways to add gold to your investment portfolio are by purchasing exchange-traded funds that buy the metal for you; buying gold mutual funds, which may own gold itself but primarily hold shares of gold mining companies; and buying gold coins.

ETFs and funds: Exchange-traded funds, sold on stock exchanges, are a cost-efficient way to own physical gold. They reflect the price of gold bullion better than gold-mining stocks, without the hassle or markup that comes with buying the metal directly. The biggest and most liquid is SPDR Gold Trust (link=http://finance.bnet.com/bnet?Ticker=GLD&Page=Quote>GLD). To keep your trading costs down, buy GLD through a discount broker. If you'd prefer to own shares of gold-mining companies, you should go with a gold mutual fund such as First Eagle Gold Fund (SGGDX) or Fidelity Select Gold (FSAGX). Keep in mind that these stocks don't behave the same way as the price of the metal; company shares are more volatile. They are, after all, paper assets representing an ownership in a business, and they are subject to operating risks and stock-market moves. Although gold funds held up better than most stocks during the worst of the 2008 crash, none of the 21 gold funds tracked by Morningstar posted a gain.

Gold coins: If you want to hold physical gold, stick with the most popular 1-ounce bullion coins minted by governments: American Gold Eagles, Canadian Gold Maple Leafs, and South African Krugerrands. You'll limit the higher markups dealers often charge on rare coins. Premiums fluctuate, so it's best to buy 1-ounce coins with the lowest surcharge. Just remember that buying coins also means paying for storage and that selling them someday can be a hassle.

James Picerno is editor of The Beta Investment Report.

More on MoneyWatch:

How to Invest in Gold
Why Cash4Gold Is a Lousy Deal
The Real Reason Gold Is Rising
Gold, Oil and More: 5 Rules for Investing in Commodities
India Prefers Gold Over Paper
Video: Soaring Gold Prices and the Economy
Don't Believe the Hype About Gold
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