Gold Hits New Highs Daily; Time to Invest?

Aug. 24, 2011— -- Many investors are caught up in a gold rush. Signs of it are everywhere. You can't turn on your TV these days without seeing ads selling gold coins or seeking to buy gold jewelry. Headlines in recent months have chronicled the rising price of the precious metal.

Since 2000, gold's price has increased more than 500 percent. This month alone, the price has jumped about 15 percent as the stock marketed has yo-yoed up and down (but mainly down), prompting investors to take refuge in the precious metal. Recent stock market volatility and concern over world economies has driven gold's price to all-time highs, reaching a record of $1,900 per ounce this week.

The underlying reason that gold has been going up in recent years -- even during calmer, richer stock markets -- is simply that many people think the price will keep rising. Regardless of why gold is going up, the rising price must mean that it's always a good investment, right?

Wrong. Though gold can have some short-term uses in a broad portfolio, it's rarely a good candidate for long-term investment. For every steep price run-up like the current one, there has been a deep trough. But unlike many other investments, including stocks, the long-term average of gold's peaks and valleys historically has had little or no real gain.

From 1979 to 2000, gold lost about half its value. And from 1979 until now, it has only doubled in price. Let's say that you bought gold in 1979 (when you could buy health insurance for the entire family for $17 a month), and sat on it for 32 years. Adjusted for inflation, you'd currently have about half of the buying power of the money you started with. About the only way you could have done worse during this period would have been to put your money in your mattress.

The result of gold's price movements is that it acquires little or no real value over time. This is because gold is a commodity, meaning that its value is determined by global trading based on supply and demand. One thing affecting price fluctuations is the large trading volumes of hedge funds. When this trading shifts rapidly, individual investors can be left in the depreciating gold dust.

Even for a precious metal, the price of gold is especially fickle because it has fewer industrial uses than silver or platinum. Gold's value is more emotionally based, and the emotional allure of gold is summed up by one of the biggest drivers of demand: the "love trade" — meaning jewelry for gifts. Another emotion is associated with gold: fear — fear that financial institutions will collapse.

People also buy gold out of greed, believing it will continue to rise indefinitely, as tech stocks did in the 1990s. Remember when that bubble burst? The difference is that, unlike tech stocks, gold has a long history of bubbles.

When stock markets and economies are uncertain, many institutional investors like to park cash in gold for the short term. Among the most common ways to invest in gold is through exchange-traded funds (ETFs). The price of shares (traded like shares of stock) is determined daily by the value of underlying gold stored for investors.