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Five Reasons Not to Be a Gold Bug


With no intrinsic value, the price of owning it could be higher than you think.

The arguments for why you should sell your cat, pawn your mother-in-law, and use the proceeds to buy gold are well known: The friendly Fed is printing money faster than you can read this; it will result in inflation; the government is borrowing like a drunken monkey; the dollar will be devalued; all currencies will be debased; the only thing that will save you is that shiny yellow metal, and so forth.

Here are some arguments, however, for why you should think twice before jumping into bed with gold bugs.

1. For investors (not speculators), it's very hard to own gold because they can't put a value on it. Unlike stocks or bonds, gold has no cash flows, and has a negative cost of carry (meaning, it costs you money to hold it). It's only worth something if people perceive it to be worth something.

2. GLD ETF (GLD) is the sixth largest holder of physical gold in the world. If its holders decide (or are forced -- think hedge-fund liquidations) to sell it, to whom will they sell it?

3. In the past, gold had a monopoly on inflation and the fear trade -- not anymore. Now you have newly emerged competition from TIPS, currency ETFs, short US Treasury ETFs, and so on.

4. If gold fails to perform because of reason number 2 or 3, the perception that gold is worth something may be violated.

5. Over the last 200 years, gold wasn't really a good investment. It may yet have its day in the sun, but it also may not. The cost of being wrong is pretty high.

The best solution to deal with the risk of dollar devaluation and high inflation -- and the one with the lowest price to pay if you're wrong -- is to own the stocks of companies with pricing power. It's these companies that will be able to raise prices during inflation, and thus remain profitable. Additionally, companies with a large portion of their sales coming from outside the US will benefit from the declining dollar.

The wild card in the price of gold is China. If the country decides to switch (partially) from owning US Treasuries to owning gold, the price of gold will skyrocket. (John Burbank made this case at Value Investor Congress in Pasadena in May).
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No positions in stocks mentioned.

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