For perhaps years investors have heard about investing in gold for variety of reasons. When we really think about gold as an investment vehicle, it's amazing how it always is a strong recommendation. In the 2002-2007 bull market for example gold was recommended because of "the devaluation of the dollar" or "demand for jewelry from developing countries".
This article clears up some of the common myths about gold through a retrospective viewpoint.
Myth 1: Recessions are good for gold.
Some may argue that gold has essentially been flat during recessions which may make them an attractive safe harbor, but it needs to be kept in mind that gold has been extremely volatile during these periods. There is lack of evidence that recessions are necessarily good for gold.
Around two-thirds of the demand for gold is jewelry and that declines in a recession. Money supply growth also flattens or contracts in a recession.
The reason why people automatically connect recessions to good for gold is mainly due to the bull market for gold during the 1970s stagflation era. It should be noted that this requires both hyperinflation and economic stagnation, which doesn't happen most of the time in a recession.
Myth 2: Conflicts and wars are good for gold.
In fact, the impact of most conflicts and crises are small on gold in the long run.
Consider, the Soviet invasion of Afghanistan in 1979 which caused gold to runup from 420s to 850. The price mostly receded to the 600s and 500s after that. Furthermore during the Gulf war despite a huge shock in the oil market, gold prices barely budged.
Seeing how events have not been prone to escalating in recent decades, the impact of geopolitical crises on gold is muted.
Myth 3: Financial meltdowns are good for gold.
Most people remember how stocks plummeted on Black Monday (October 19, 1987). But the impact on gold is less remembered. Gold closed at $465.50 on 10/16/1987 and $481 on Black Monday. On 10/20/1987, gold actually closed at $464.30, lower than before the crash. This is amazing how gold receded so quickly in one of the worst meltdowns in financial history.
On March 14 2008, gold hit an all time high of $1030/ounce as Bear Stearns went kaput. Yet this marked the peak for gold for the rest of the year as priced quickly retracted. On September 15 2008, Lehman Brothers declared bankruptcy, in fact, the largest in history. Gold prices went from $775 to $900 but quickly fell back to to the $700s.
Most of the time, investors hear about end of the world scenarios as reasons to buy gold. But in fact, gold has not done well whenever the end of the world seems to approach. The logical explanation is that, financial crises are expected to cause deflation. With fewer dollars floating around, their ratio to gold decreases and the price of gold decreases.
Myth 4: Gold is a good hedge against inflation.
By many historical estimates, gold should be around $2000 /ounce now. Most gold bugs believe that CPI understates true inflation and gold should be in the thousands. However, gold is at $9xx /ounce currently and if gold really was in fact a true hedge against inflation the market would've taken gold to $5000/ounce already.
This was a guest post by StockTradingToGo Community member Allen. View more posts from this author.