Aug. 10, 2005 - Not All That Glitters Is Gold

The advertisement in the current issue of World Magazine has all the classic ingredients to suck you right in -- enticing question, amazing statistics, and assertive predictions. 

How can you go wrong?  You can't, according to the ad, because the value of this investment has never been zero.  What are they talking about?

Gold!  Pure gold!

Here's is what the ad says.

• Enticing Question
  • "How do your investments stack up?"
• Amazing Statistics
  • "Throughout history, its value has never been zero."
  • "The last time interest rates were this low and started to rise, gold prices skyrocketed over 300%."
• Assertive Predictions
  • "In a recent Barron's article, gold was predicted to again reach its historical high of $850/oz. due to a weak dollar and soaring budget deficits."
  • "The Gold/Oil Price Ratio says gold should now be trading at $770/ounce."
  • "1.2 billion Chinese citizens can now legally own gold.  This new demand alone is expected to drive gold prices above $800 an ounce...nearly double what it is today."

WOW!!!  Sounds fantastic!!!  Where do I buy???

Slow down, wipe the saliva off your chin, and let's consider this more carefully.

I'm not against gold and it does have a place in a well-diversified portfolio.  But before we're tempted to go overboard here, let's look at things logically instead of emotionally.

I want to use this ad to demonstrate how to read any investment pitch with a critical eye and a logical mind.  This is an invaluable skill that may save you money and untold heartache someday.  Pay attention!

Consider each of the above statements from the ad and their relevance to the investment decision you are subtly asked to make through the "enticing question."

1.  "Throughout history, its value has never been zero."  True.  Neither has the value of Microsoft stock since it went public.  Nor General Motors for that matter.  Or a host of other companies or commodities.  What does this statement have to do with evaluating the worthiness of making an investment in gold now?  Nothing.  Disregard it.  The intent is to appeal to our fears.  Investing based on fear is not a good strategy.

2.  "The last time interest rates were this low and started to rise, gold prices skyrocketed over 300%."  I wonder about the accuracy of this statement since they don't provide a time frame.  Gold prices only rose dramatically in the mid- to late-1970s but interest rates at that time were hardly "this low."  In fact, during the early-1970s interest rates were about 3% higher than today's levels and then they went up considerably from there.  But interest rates aren't really the key.  It was the rapidly increasing rate of inflation in the 1970s that drove the price of everything higher.  While interest rates are going up right now, there are no signs of rampant inflation -- even with soaring energy costs.  This is an appeal to greed.

3.  "In a recent Barron's article, gold was predicted to again reach its historical high of $850/oz. due to a weak dollar and soaring budget deficits."  Is that so?  And is Barron's the owner of a crystal ball that we should automatically assume their pronouncements as truth?  Hardly.  Financial publications make predictions all the time.  Some come true but many others don't.  This is just another appeal to greed by using a respected publication's good name to give credibility to the ad.

4.  "The Gold/Oil Price Ratio says gold should now be trading at $770/ounce."  Oh really?  Then why is gold trading at $435/ounce?  I guess all of us stupid humans just haven't figured out how brilliant the gold/oil price ratio really is.  An enterprising individual can concoct a set of statistics to support any argument.  What gold should be is a matter of opinion and is irrelevant.  Another appeal to greed.

5.  "1.2 billion Chinese citizens can now legally own gold.  This new demand alone is expected to drive gold prices above $800 an ounce...nearly double what it is today."  Interesting information but not necessarily a great predictor.  The Chinese have been allowed to legally own gold since October 2002 -- nearly 3 years.  When will this boom occur?  Maybe it already has or maybe it never will.  This is yet a final appeal to greed.

Here's the bottom line. 

The company running this ad makes its money selling gold it owns to the public.  Are they a credible source of information?  I don't know.  But if they really believe anything they've written in their own ad, then why are they so anxious to sell gold to me at $435/ounce?  Why not hang onto it and double, triple, or quadruple their money?

The truth is that they have no clue which way gold prices will go either.  But the more gold they trade, the more money they make (on commissions) -- no matter what the price does.

Gold may go up or it may go down.  If you own gold, I hope you make a fortune.  That's not the point.

The point is that you must evaluate every financial pitch before taking action.  Appeals that play on your fears or greed generally do not have much substance to them.  Be careful!

It also pays to do a little homework.

It seems very impressive that gold has risen from its recent lows of $252/ounce in 1999 to a peak of $454 in 2004.  That's an 80% increase in just 5 years!  But in the longer term, it has only risen 7% since its 1990 peak of $424/ounce and has actually fallen 47% since its all-time peak of $850/ounce in 1980.  And that doesn't even account for inflation.

As the old saying goes, not all that glitters is gold.  Sometimes, not even real gold!