Weighing the Downsides: The Disadvantages of Investing in Gold

May 26, 2024

Fool’s Gold: Unmasking the Disadvantages of Investing in Gold

Introduction

Gold has long been esteemed as a symbol of wealth and security, cherished by individuals and societies. Many investors gravitate towards gold, seeing it as a haven during turbulent times and a hedge against inflation. However, as with any investment, it’s not without its drawbacks. This essay highlights the disadvantages of investing in gold, providing a comprehensive view of what one might consider before buying this precious metal.

1. Volatility of Gold Prices

The global economy is a complex web of intertwined elements, and one of the critical puppeteers of gold prices is interest rates. When interest rates rise, the allure of holding gold, which does not yield interest, diminishes. Investors are more likely to gravitate towards assets that generate returns, causing a dip in gold prices. Conversely, gold regains its sparkle when interest rates fall and prices climb.

Another critical player in the gold price drama is geopolitical tension. As uncertainty grips the world due to conflicts, war, or political instability, investors often turn to gold as a “haven.” This rush towards gold in times of crisis inflates its price, creating a bubble that may eventually burst when stability is restored. A prime example of this was the financial crisis 2008, which saw gold prices soar as investors sought refuge in the precious metal, only to watch it plummet in the following years when the crisis receded.

Market volatility also plays a significant role in the ebb and flow of gold prices. Investors often flock to gold in periods of high market volatility, seeing it as a stabilizing force amidst the economic storm. However, as the storm calms and market volatility eases, the demand for gold softens, leading to a drop in its price.

The volatility of gold prices underlines the inherent unpredictability of investments. It demands a keen understanding of global economic factors and a patient, measured approach to investment. While gold continues to glitter, its price volatility is a reminder that all that glitters is not always gold.

2. Lack of Passive Income

In the realm of financial investments, gold is a silent player. Unlike its vocal counterparts, such as stocks, bonds, or real estate, gold remains mute, refraining from yielding dividends, interest, or rental income. When you invest in gold, your returns are tethered to the whims of its price movement. Your profit materializes only when the price of gold appreciates, and you decide to sell.

In stark contrast, other assets offer their investors a melodious tune of regular income. For instance, stocks and bonds generate dividends and interest, respectively. This periodic payout is a reliable source of income, independent of the asset’s price fluctuations. Similarly, real estate investments can provide a steady stream of rental income, creating a cushion of financial security for the investor.

This constant flow of income can be particularly beneficial for long-term investors. It offers a consistent return on investment, which can compound over time and contribute significantly to wealth accumulation. Moreover, it provides financial stability, enabling investors to plan their finances with certainty.

The absence of passive income from gold investments underscores the importance of diversification in an investment portfolio. While gold can act as a hedge against economic volatility, other income-generating assets can provide a steady income stream. This balanced approach can cater to the thrill of potential price appreciation and the comfort of regular income, creating a well-rounded investment strategy.

3. Storage and Insurance Costs

Storing gold securely is a significant challenge for investors. Home storage is risky due to theft and damage, while professional storage services, though secure, add substantial costs. Insurance premiums further reduce potential returns.

According to a review by SchiffGold, a precious metals dealer, “One requirement for setting up a precious metal IRA is that the precious metals one invests in must be stored by an independent, government-approved storage service provider.” The review notes that SchiffGold’s network of top-rated storage providers can help navigate this challenge.

However, some argue for home storage in extreme crisis scenarios. A ZeroHedge article quotes a hypothetical situation: “Think about it this way – you have stashed your gold in a storage vault somewhere, but then a crisis occurs, and all systems break down. There’s no way to access your stored gold because, well, street gangs have raided the vaults, and the criminal justice system as we know it doesn’t exist.”

4. Illiquidity

Physical gold is less liquid than financial assets like stocks or ETFs. Selling involves finding a buyer, negotiating terms, and potentially transporting the gold, which is time-consuming. Gold ETFs offer better liquidity but still face challenges in volatile markets.

A European Central Bank article notes the difficulty in getting reliable crypto-asset data due to “unusual spikes and erratic trading behaviour.” It highlights the “substantial risks of cyberattacks and other operational risks” affecting crypto trading platforms.

Gold’s price volatility, influenced by factors like inflation and geopolitics rather than industrial demand, can impact the amount recovered upon sale. Understanding an asset’s liquidity is crucial for a well-rounded investment strategy.

5. No Tax Advantage

Gold investments often lack the tax advantages of other assets. Many jurisdictions treat gold profits as capital gains, taxed at potentially higher rates than dividends or interest. Gold investments also typically lack tax deductions or exemptions for confident retirement or education accounts.

A Reddit discussion on a Peter Schiff debate notes, “While BTC might not have IRL application other than money, BLOCKCHAIN as a global decentralized ledger has real-world application” beyond just serving as a store of value. This suggests the technology underlying Bitcoin may have broader tax implications.

To accurately assess profitability, comprehensive financial planning must account for an investment’s total costs, including tax liabilities. Gold’s tax disadvantages underscore this need.

6. Limited Industrial Use

Gold has some industrial uses in electronics and dentistry, but this represents a small fraction of its overall demand compared to its role as a financial asset and in jewellery. In contrast, metals like silver and palladium have extensive industrial applications.

A Cointelegraph article quotes Peter Schiff, arguing that Bitcoin holders “think they’re going to get rich on Bitcoin” rather than genuinely viewing it as a store of value. Schiff contends that gold’s real-world uses give it the lasting value that Bitcoin lacks.

However, a European Central Bank article notes the difficulty of naming and identifying crypto-assets and the “substantial risks of cyberattacks and other operational risks” that can disrupt crypto trading. This suggests that even purely digital assets face practical challenges.

Gold’s limited industrial use makes its price more dependent on investor sentiment and speculation than real-world demand. This can lead to higher price volatility that investors must navigate.

7. High Transaction Costs

Investing in physical gold involves costs beyond the metal’s price, including broker fees, shipping, handling, minting, and casting charges. Selling gold also incurs broker fees and potential appraisal costs. These transaction costs are higher compared to digital assets like equities.

According to a FINRA article, investors should be aware of the risks and costs associated with physical precious metals, which are not covered by the Securities Investor Protection Corporation (SIPC) as they are not registered securities.

A TheStreet article notes that gold carries high transaction costs and commissions, similar to the markups in the jewellery trade. Some of the initial buy-in goes towards the business of gold and is never recovered, akin to realtor or broker fees. There are also additional costs for storing gold.

BullionVault’s gold cost calculator factors in various expenses, such as commission tiers and minimum storage charges for different currencies, when calculating the total cost of buying, storing, and selling precious metals.

These high transaction costs necessitate careful calculation when considering a gold investment to ensure profitability. Investors must factor in these costs when assessing potential returns.

8. The Impact of Political and Economic Instability

Political instability, such as coups, revolutions, or elections, can affect the global economy and various investment assets, including gold. Uncertainty drives investors towards perceived safe havens like gold, increasing demand and prices. However, resolving political tensions or the emergence of a stable government can reduce gold’s appeal, leading to price drops.

Economic instability, such as recessions, financial crises, or high inflation, can also significantly impact gold prices. During such periods, traditional assets like stocks and bonds often face downturns, prompting investors to seek refuge in gold and driving up prices. As economies recover and stability returns, investors may move funds back into equities and bonds, causing gold prices to fall.

Geopolitical events like wars or trade disputes can complicate gold’s pricing dynamics. These events often breed uncertainty and fear, driving investors towards gold and triggering price spikes.

A European Central Bank article highlights the difficulty in getting reliable data on crypto-assets due to “unusual spikes and erratic trading behaviour” and the “substantial risks of cyberattacks and other operational risks” affecting crypto trading platforms. This suggests that even digital assets face challenges during times of instability.

Gold’s status as a haven can provide some protection during turbulent times, but it also makes it susceptible to price volatility driven by global events. Investing in gold requires a keen understanding of international political and economic landscapes and the importance of staying informed in the ever-changing world of investments.

Conclusion

While gold has traditionally been viewed as a stable and reliable investment, there are clearly significant disadvantages to consider. The volatility of gold prices, its inability to generate passive income, storage and insurance costs, illiquidity, tax implications, limited industrial use, high transaction costs, and susceptibility to geopolitical and economic instability can all negatively impact the attractiveness of gold as an investment.

Despite these drawbacks, gold may remain in a diversified investment portfolio as a potential hedge against inflation and currency fluctuations. However, due to the risks and disadvantages discussed, it should not be relied upon as the primary or sole investment. As with any investment, thorough research and consideration are essential before diving into gold investing.