As an Austrian, I’m a huge fan of having a good bit of gold in my long-term investing portfolio. It’s served me well in the last few years, and has helped me beat the market while the market either stayed flat or fell after inflation.
Unfortunately, some free market believers are confused about the nature of gold as an investment, and are convinced that owning gold is the only thing their portfolio should do — and that doing this will make them plenty of money. This is only partially true. Gold should be part of one’s portfolio — but only part of it.
I explain my reasoning below.
Gold is Not Magical
Gold doesn’t magically keep up with inflation over the short-run — it usually does over the long run. What this means is that it’s possible to see 3-5% inflation every year for years while gold prices slowly lag behind. This has happened before and will certainly happen again.
Gold, like every asset in existence, is priced on the basis of supply and demand. Unfortunately, it’s almost impossible to price gold according to traditional investment analysis like earnings-to-price ratios because, well, gold doesn’t have one.
Don’t take this out of context, of course — I’m a huge fan of gold. I’ve seen plenty of profits from gold over the last few years, and have fluctuated my gold holdings at 10-30% of my portfolio over the last few years. I’m not planning on ever taking it below 10%.
Gold is Expensive
But just because I like an investment doesn’t mean that it’s always going to perform well.
Gold, even after inflation adjusting the prices, is nearly 2-3x its historical price of roughly $750. This means gold is expensive compared to its historical price. Does this mean there’s no more room to grow? Of course not.
I won’t make a prediction about when exactly a correction will occur, because I think that exact predictions are almost always extremely foolish. The more variables that are in play, the less likely a prediction is to be correct — regardless of one’s understanding of Austrian economic theory.
We’ve Been Here Before
Don’t forget, the gold market has seen massive bull markets in the past. Just a few decades ago, stagflation, recession, stock crashes, and fear that “this time it’s different” took hold of millions of people, and gold went skyrocketing to all time highs.
Whenever analyzing a market, before saying, “this time it’s different!” just look to history and see if it really is any different. There are obviously always going to be different variables at play, but you’ll usually see that radical predictions are rarely true. This doesn’t mean all radical predictions are false, but it means we should be skeptical of most.
What All of This Means
Where there’s uncertainty, diversity is important. Unfortunately, plenty of politically correct investors think “diversity” just means owning different types of stocks from the same country. Diversity is much more than this.
A diverse, well balanced portfolio is one that has plenty of traditionally high-performing assets, and mixes them together. Nothing completely lopsided, because it’s unnecessary. Gold, silver, international dividend stocks, Swiss currency — each of these are good building blocks for a strong portfolio.
As for what the future of the gold market holds, several months ago I wrote an article explaining that there are basically two options:
Currency Crisis Now.
World currencies, notably the US Dollar, start to tank on a massive level. Not just typical inflationary drops, but on a level that isn’t even currently happening. This would send gold higher for quite some time, if not decades. It depends on how long the monetary crisis lasts.
Currency Crisis Later.
This is more likely. This is when we’ll start seeing “light” at the end of the tunnel, stocks will peform well for a bit, and people will realize that gold can’t go up forever. Because of reflexivity, the gold market will probably dramatically overcorrect, meaning gold will essentially become cheap again. But the story doesn’t end there — we know there’s no such thing as a free lunch, and the proverbial feces will still need to hit the fan at some point in the future. That’s why gold is a buying opportunity when it drops under this scenario.
Those are the two ways gold could keep going higher. One happens in the short run, and one happens in the long run. Either way, I’m still adding more to my balanced portfolio, including gold holdings — and will probably do this even if we start seeing a strong correction in the near future.
Editors Note: Since this article was received for publication, gold prices have dropped more than $100 per ounce.