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$mart Money: Why does anyone care about gold?

Gold is an interesting investment. It's got a few thousand years of history on its side, and right now gold is very much in vogue, with nominal prices setting new record highs.

Gold is an interesting investment. It's got a few thousand years of history on its side, and right now gold is very much in vogue, with nominal prices setting new record highs.

Something that puzzles me, though, is why anyone cares about gold anymore. Sure, gold was historically important. The cotton gin, spinning jenny and steam engine were all historically important too

Still, gold has some kind of pseudo-mythical attraction for some people. Personally, I fear the myth part might be the key element here; it's hard to justify the attraction as being based in reality. Sometimes it seems to me that people look at gold with blind faith and adulation, and really haven't thought through the idea of gold as an investment.

As Warren Buffett said, "Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

Even so, some of the people who like gold really, really like gold. There are a few reasons why gold may be thought of favourably.

Some people think that gold is a good hedge against some kind of economic catastrophe, like plummeting currencies or rampant inflation. But is it really?

It has been decades since currencies were backed by gold. The Canadian dollar, the US dollar, the Euro, Japanese Yen - all the major currencies in the world, in fact - are fiat currencies. Their value comes from the fact that the various governments have declared them to be legal tender, not because you can take the paper to some central vault and walk out with a set amount of gold.

Here's an experiment for those that think gold has some role to play as a currency. Try taking a gold bar into the grocery store to buy a box of breakfast cereal. Watch the fun ensue when the store clerk has no idea what to do. Even better, let's say the store does accept the gold as payment. How are they going to give you your change?

If gold was going to be a commonly accepted currency substitute it actually has to be commonly accepted. Once upon a time you could pay for your groceries in gold, but that was a long, long time ago.

Anybody that is buying gold in the event of a currency collapse is actually making two separate long-shot wagers. The first wager is that there is a currency collapse at all, and the second wager is that gold is the beneficiary of such a collapse.

If there was some kind of currency collapse there is nothing to say that gold would have any particular value. It might as well be diamonds that people turn to, but gasoline or bullets would be more practical items for barter.

A second reason that some people buy gold is as an investment, speculating that the price will continue to increase. All things being equal, this is almost always a terrible reason to buy something.

Think about it. Gold has already appreciated from $253 an ounce in 1999 to $1,250 an ounce in 2010. Where do you think it is going to go from here?

Before you start salivating about going from $253 to $1,250, keep in mind that in 1980 gold was at $850 an ounce. In inflation adjusted terms gold would have to go to about $2,200 an ounce for it to be worth what is was 30 years ago. Gold has actually been a lousy hedge against inflation.

But even if we leave out the long ski-jump pattern that inflation-adjusted gold prices have seen over the last 30 years (that is, precipitous early declines with a more recent ascent), and just focus in on the rise from $253 to $1,250, its sheer foolishness to take the price history of the last 11 years and extrapolate that torrid rate of change into the future as a reliable indicator of sustainable growth. Doing so would mean succumbing to the mental mistakes that had people thinking it was a good idea to buy tech stocks in 1999, or US real estate in 2007. Or buying gold in 1980, for that matter.

One reason to buy gold that actually does make sense is for diversification. That's legitimate. Kind of late to the party maybe, but diversification is a legitimate reason to own gold. It's just that you might want to keep the allocation to five or ten percent of your portfolio, rather than making big bets that extreme conditions are not going eventually revert back to the mean.

Interestingly, none of this matters to a true gold bug. They think that gold is going to be their life preserver and their winning lottery ticket all rolled into one, and they aren't going to let facts or logic get in their way.

For those on the fence though, here's how gold actually stacks up.

Let's say that you had $1,000 to invest in 1980, and you had a choice between buying gold bullion and enjoying the ride to $1,250 per ounce, or buying the Toronto Stock Exchange index, and having suffered the painful setbacks that occasionally occurred in the stock market over the years.

From 1980 to 2009 gold bullion grew at a compound annual rate of - are you ready for this? - a meagre 2.184 percent. Over those 30 years gold declined in 14 of them, or 47% of the time. The worst drop was in 1981, when bullion declined 42 percent in a year, and took 25 years to recover.

$1000 invested in gold bullion in 1980, even having benefitted from this recent run to record nominal prices, would be worth $1,912 now.

Alternatively, a person could have invested $1,000 in the Toronto Stock Exchange in 1980. While that wouldn't have been the best place to put your money - other indexes performed better, and 2008 certainly took a little of the polish off - you would have grown your money at a compound annual rate of 9.428 percent. You would have had 9 down years, which is 30 percent of the time frame. The worst drop was 2008, from which we are still recovering.

Even so, $1000 invested in the Toronto Stock Market in 1980, even having been pounded by the 2008 financial tsunami, would be worth $14,924 now. That's 780 percent more than gold bullion.

Sorry fellas. The time to buy gold - if there was one - was a decade ago. The easy money has already been made. Now I think that we are in the danger zone.

Don't believe me? Just ask the guys that bought gold in 1980 at $850 an ounce, only to watch it drop by seventy percent and then had to wait a generation for the prices to come back.

The opinions expressed are those of Brad Brain, CFP, R.F.P. CLU, CH.F.C., FCSI. Brad Brain is a Certified Financial Planner with Manulife Securities Incorporated, Member CIPF and with Manulife Securities Insurance Agency in Fort St John, BC. Brad Brain can be reached at brad.brain@manulifesecurities.caor

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