Thursday, September 24, 2009

Should You Invest in Gold Now?

Most investors in the U.S. stock market have seen their “nest eggs” plummet faster than January temperatures in Nebraska. For example, investors who purchased a basket containing one share of each the Dow-Jones Industrial 30 in 1999 lost almost 20% of their investment over the past decade. On the other hand, the investor who invested his/her bundle in gold experienced a gain of 262% during this same time period. What accounts for gold’s superior return? Rising inflation, a cheaper dollar, an expanding economy, and escalating risks account for gold’s fantastic returns. But among these four factors, investor’s risk assessment dwarfs the other three in terms of influence on the price of gold. The best measure of financial risk is the gap between the yield on corporate bonds and U.S. Treasury bonds. As risks rise, investors sell corporate bonds and buy risk free U.S. Treasury bonds. This increases the yield on corporate bonds and decreases the yield on U.S. Treasury bonds widening the gap between the two. If risks rise to levels existing in January of 2009, gold prices are likely to soar by as much as 78% from the current price. However, if risk declines to the level existing in November 2007, one month before the recession began, gold prices will plunge by approximately 11%. Thus, investors’ decision to buy gold should hinge on their assessment of the direction in financial risks. A return to the scary financial environment of early 2009 will reward gold buyers handsomely, while a more soothing economic climate will inflict losses on the gold buyer.

Ernie Goss

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