Before you sell that last piece of jewelry, keep in mind that the gold price will not go up indefinitely. There are number of reasons why it might crash.
Continue Reading Below
If youre overweighted in gold or commodities, the warning is the same: A stronger dollar, strengthening U.S. economy or rising interest rates could derail the epic yellow metal mania. Who knows? Congress could even reach an agreement to clear up its balance sheet and pay down its debt.
What are the chances of any of this happening? Its beyond the limits of my minuscule, clouded crystal ball, which is about the size of a pinhead. Nevertheless, you should prepare your portfolio for any number of eventualities, which can be easily accomplished with exchange-traded funds. Gold is troublesome in my book because it really isnt an investment. Its a reserve currency of sorts thats heavily traded by institutional investors. It doesnt pay any dividends or interest and is bought in times of widespread fear.
The savviest traders buy gold as a hedge against the dollar. In the past few years, its also been a bulwark against the Euro as well, which has been bruised by sovereign debt woes in Greece, Ireland and Portugal.
Is the Euro financial fizzle over? I dont think so, but its still not a reason to load up on gold. The clearest threat to golds reign as the reserve currency of nervous Nellies is a possible rebound of the dollar. Given the congressional wrangling over the debt limit, budget and growing inflation, betting on the buck is like trying to figure out whether a racehorse will finish. They often pull up lame.
Whats interesting is the relationship between gold, mining stocks, the dollar and the S&P 500 Industrial Index, the broad basket of the largest U.S. companies.
When the dollar shows signs of reviving, gold drops. Shares in ETFs like SPDR Gold Shares will reflect that decline. The fund holds bullion and tracks spot prices fairly closely.
If you wanted to hold gold mining shares that reflect earnings from precious metals companies, its like a leveraged play on the price of gold. In one monthly period (from April 23 to May 23), the price of the Market Vectors Etf Gold Miners Trust fell about 10 times as much as the SPDR fund. Market Vectors reflects an index of gold mining companies. Similar funds showed the same kind of decline.
During the period I chose in which the dollar showed a minor rebound the Powershares DB US Dollar Index Bullish Fund was up almost 3%. The fund basically makes money when the dollar gains against other currencies.
By now, you can see a pretty simple pattern. Gold and the dollar generally move inversely to one another. It gets more complicated when you add stocks in the mix, which are based on expected earnings. They are often hurt by predictions of higher inflation or lower economic growth, both of which are uncertain now.
In a speculative portfolio, you can go long on worldwide stocks through a fund like the Vanguard Total World Stock Index ETF, own gold through the SPDR fund and go either way on the dollar. Powershares has a bearish version of its dollar index fund. And, last but not least, you can also bet against gold through the Proshares Ultrashort Gold ETF.
That brings up a key question that most individual investors struggle with when they start worrying: What should I be most concerned about?
Stick to your long-term goals. Only professional traders who have the discipline to make quick trades will get out and make a profit. If you try to time or short any vehicle, youll be stuck holding the bag. If you need income, forget about the rest of the world and find the safest investments at the lowest possible cost. Your second goal would be to protect yourself against loss of purchasing power through a fund like the Vanguard Inflation-protected securities fund.
Still stuck on the need to own gold? What about the imminent collapse of the American and European economies?
Before you pawn your wedding ring, keep in mind that in real times of crisis the metal wont replace food or water. As Voltaire reminded us in Candide, it would be better to tend to our gardens.
Continue Reading Below