Rather than declaring the merits of gold (or the lack thereof), we post this article to stimulate awareness of some key arguments. Please remember Proverbs 16:16 — “How much better to get wisdom than gold, and good judgment than silver!” Since gold isn’t edible, most ZLMers would be better served to maintain three days’ (or weeks’) worth of water and canned food than a stack of coins.–Mark Levitt

By Will Deener Dallas Morning News 01 July 2012

About a year ago, as gold prices were hitting record highs, gold bugs were brimming with I-told-you-so bravado.

Not so much now.

After topping out at about $1,900 an ounce in August 2011, gold prices currently hover around $1,600 an ounce — a 15 percent slide. I mention this because in past columns, I incurred the wrath of gold investors by suggesting that gold was priced as if Armageddon were at hand.

Buying gold as a hedge against the end of the world is fine by me, but to paraphrase one Wall Street sage: The world will end only once, so you better time that trade just right.

Truthfully, my position on investing in gold has been consistently inconsistent. I was for it until I was against it; but now I think I want to own some of it except for the times when I don’t. As you can see, I’m a tad conflicted when it comes to gold.

I fully recognize that gold bugs have been on the right side of this trade for the better part of 10 years as gold prices soared from about $300 an ounce to $1,900.

The recent slide in gold prices notwithstanding, I admit that the gold bugs have a point. Let’s just say my position on gold is evolving.

But before I kneel in deference to their investing prowess, I have three observations to make, or what I like to call “facts.”

First, when I ask people why they own gold, they often tell me it is because it is a hedge against a falling stock market. In other words, if the market falls, gold prices will rise and vice versa.

Hmmm. That’s interesting, but it’s not true. The correlation between stock returns and gold prices is essentially nil, according to Eric Weigel, senior research analyst at the Leuthold Group, a Minneapolis investment research firm.

There have been many times over the years when gold prices dropped in tandem with the market. The yellow metal provided no downside protection.

“There doesn’t seem to be any sort of consistent relationship between gold and stocks,” Weigel said. “There are long periods, such as from 2001 to 2006 when there is simply no relationship at all.”

Investors who want to hedge against a falling or volatile stock market would be better served by buying bonds rather than gold, Weigel said. There are even exchange-traded-funds (ETFs) that move in the opposite direction to the stock market, and would probably offer a better hedge against a sagging market.

Sophisticated investors sometimes will buy the ProShares Ultra VIX Short-Term Futures ETF as downside protection. These types of ETFs are not for the faint of heart because they are volatile, but then so is gold.

My second observation involves another common reason investors cite for their love of gold: They buy it for protection against inflation.

It is true that gold prices tend to track inflation, but the correlation is not as strong as the gold bugs would have us believe. In fact, in late 2005 and 2006 as inflation dropped, gold prices rose.

The point is that there are better and more direct inflation hedges than gold. For example, Weigel advises anyone concerned about inflation to invest in Treasury Inflation-Protected Securities (TIPS).

“There are even some other hard assets, such as timber, that offer a steady stream of cash flow in addition to inflation protection,” he said.

By the way, Weigel seriously doubts that inflation is even an issue any time soon, with such a lethargic economy, low wages and falling fuel prices. Those who want to buy gold as an inflation hedge may consider waiting until there is actually the prospect of some inflation.

My final observation puts me back on the side of the gold bugs. They believe gold is a hedge against currency devaluation. I don’t disagree with that, and this is by far the best rationale to buy it.

Gold prices really soared over the last two years as the value of the dollar declined — meaning the correlation was strong. The U.S. central bank and central banks in many other countries have flooded their financial systems with money — essentially just printing their currencies — to bolster economic growth.

Printing money, when taken to such extremes, will ultimately undermine the value of currencies. Weigel said the correlation between the value of the U.S. dollar and gold has been particularly strong over the past two years.

“Before that, gold prices and the U.S. dollar had a weak association, but I think going forward, gold will be a good hedge against eroding currencies,” he said.

For investors, the point of all this, is to know why they own gold. If it is to protect against a volatile stock market or inflation, there are probably some better hedges.

If it is to protect their portfolio against eroding currencies, that’s not a bad idea, and at least that strategy is based in fact.

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