Gold May Rise, But Is It Safe?

Gold’s hype may blind average investors to its inherent risk.

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In a recent interview on the website Mineweb.com, Chris Eibl, head of trading at Tiberius Asset Management, echoed this feeling: "I personally fear the risk of investors deciding not to buy [gold] on a certain day. A day when people come to the conclusion that [the crisis] has softened out and say we don't actually need to buy gold. On that day you can be pretty sure that gold drops a couple of hundred bucks."

Comments like this point to skepticism about gold's oft-cited virtue as a hedge on inflation. Although many academics believe that gold has kept up with inflation over the long run (the last 200 hundred years), the metal hasn't done so in shorter periods. In the back of gold skeptics' minds, like Chris Eibl, is the fact that, when inflation is factored in, the metal still hasn't regained its 1980 average of $612 more than 30 years later. Many gold analysts are calling for gold to reach this point ($1,622) sometime in 2011. So if gold didn't track inflation for the past 30 years, should you bet it will now?

Consider that when John Paulson stated, according to Businessinsider.com, during a New York University Club speech in mid-September that gold could go as high as $4,000 an ounce, he was not predicting its true worth, but admittedly guessing that the price would "overshoot" inflation. This means that investors like Paulson are actually counting on a bubble. So even if you don't believe in the gold bubble, realize that the market movers are hoping to cash in on one.

Gold bulls will tell you that the Fed's inflationary policy of keeping interest rates low and buying up large amounts of securities from the private sector will continue to send investors into gold as a safe haven. It's common knowledge that "printing money," the common term for the Fed's second stab at quantitative easing, could cause inflation that will devalue the dollar and any assets denominated in dollars, such as stocks. "Everybody always knows that government is spending all this money. That information is already out there. The price moves in advance, not [after the fact]," warns Adam Bold.

At the end of the day, while gold has long been a traditional safe haven, you might not want to get in now. This is especially true if you just have a few more years before retirement. Although U.S. stocks are not popular at the moment because of economic uncertainty, they're relatively cheap compared with expected future earnings. "You've got 150 out of the stocks in the S&P 500 that are yielding more than the 10-year treasury. That hasn't happened since 1958," says Dirk van Dijk, director of research at Zacks Investment Research. "Based on historical risk and potential return, gold just doesn't have the same risk/reward ratio." Like other gold skeptics mentioned here, Dijk thinks that though gold may well be a good investment in the short term, its past record shows that if it drops precipitously, it doesn't necessarily recover quickly. After all, instead of trading sideways for 22 years like gold after its 1980 bubble, following the dot-com bubble in 2000, the S&P 500 regained its highs within 7 years. Even in the market's current uncertainty, the S&P 500 has already rebounded 75 percent from its 2009 low.