Getting in on the gold rush - the smart way
The price of gold is past $700/oz. Will it go higher still? Is there a way for me to benefit?
By Walter Updegrave, MONEY Magazine senior editor

NEW YORK (CNNMoney.com) - When the price of gold shot past $600 last month for the first time in 25 years, I figured I'd missed a big opportunity. Now it has risen past $700. Will it go higher still? Is there a way for me to benefit?

- Anonymous, New York City

Funny thing about gold. After it's experienced a huge run-up and is sitting at a price where you can't help but wonder whether there's much more upside left in the near future, people can't wait to join the gold rush.

But when gold is selling at price where presumably it would have much farther to run - as recently as May, 2003 it was trading at just $350 an ounce - nowhere near as many people are clamoring to get into it as they are today. In fact, gold often drops completely off investors' radar screens.

The glitter of gold

Which brings me to what I think is one of the most interesting, and dangerous, aspects of gold as an investment: we're most eager to invest in when its emotional appeal is high but its return prospects are murky at best. And we're least enthusiastic when it might actually be a bargain.

I won't kid you. I have no idea whether gold is going to continue its upward march, matching its January 1980 high of $850 an ounce and then going on to even higher ground. I think it's pretty clear, though, that what's driving it are the forces that have boosted gold prices in the past, namely, concerns about inflation (i.e., rising oil prices) and geopolitical jitters (i.e., nuclear standoff with Iran, war in Iraq and Hamas to name a few).

So if you think that we might see a significant uptick in inflation and that various political hot spots around the world will continue to rattle investors' cages enough to maintain gold's allure as a haven in an uncertain world, then its prospects could be quite good.

Some gold bugs also note that if you adjust gold's record price of $850 for inflation, it translates to more than $2,000 an ounce in today's dollars. To them, this suggests gold still has plenty of room to run (although I know of no rule that says gold's value has to keep pace with inflation).

On the other hand, if you think that new Fed chairman "Big Ben" Bernanke will do all he can to keep inflation in check (and the Fed's latest 25 basis point rate hike as well as the Fed Open Market Committee's subsequent statement suggests to me Ben and the boys are on top the inflation situation) and you believe that, despite various political problems, the world really isn't about to implode, then you would have to figure that the gold's upside is limited.

For a solid metal, gold is pretty volatile

Whichever way you come down on those issues, there's one important thing you ought to keep in mind: gold is one of the most volatile investments around. As a practical matter, that means that big spikes in its price are often followed by drop offs that are just as steep, if not steeper. This sort of rollercoaster up-and-down ride has been gold's trademark for at least the last 30 years.

As I see it, there are two ways to play gold. One is to try to time the ups and downs - that is, buy when prices are low and sell after gold has spiked. I think this is a dangerous game for most investors because they're likely to get into the game late and end up doing the opposite, buying high and then selling after gold declines.

If you think you're up for this sort of strategy, I would suggest you ask yourself this question: Did you buy gold a year ago when it was selling for about $420 an ounce? If not, why do you think you know more about gold's prospects today than you did a year ago?

I think most people, if they're being honest, will answer that they don't have any particular insight into gold. They're just caught in the euphoria of the rising price and don't want to miss out on a good thing. To me, that's not a reason to buy gold, or any other investment for that matter.

Dip a toe in the water if you must

But there's a second way to play gold that I think can make much more sense for most investors. And that is to invest a small portion of your portfolio - say, 5 percent or so - in gold as a long-term diversification strategy and inflation hedge. Each year, as part of your regular strategy of rebalancing your portfolio to restore your mix of assets back to its normal position, you would then sell gold if it's risen in price and therefore become a larger part of your holdings. Or you would buy more gold if it fell in price and became a smaller part of your holdings. In other words, the idea is to maintain that 5 percent or so exposure over time by buying more or taking profits along the way.

This strategy has several benefits. First, it forces you to sell some, but not all, of your gold holdings, when the price is rising. And if forces you to buy some gold after the price has fallen. In other words, it prevents you from making an emotional decision to buy or sell based on the current price of gold and the euphoria or gloom related to that price.

Another benefit of this diversification strategy is that you get to take advantage of another of gold's signature features: its low correlation with the stock market. Even though gold is more volatile than the stock market, it doesn't move in synch with stock prices. So by adding some gold to your portfolio, you can actually lower the volatility of your portfolio overall. That may sound like an investment version of alchemy, but it's true.

As for the practical matter of how to buy gold, there are more options today than ever before. You can buy gold coins, gold bullion, gold bullion online, gold stocks, mutual funds that invest in gold and other precious metal stocks and gold exchange-traded funds (ETFs). The World Gold Council gives a nice explanation of these options.

If for no other reason than convenience of buying and selling, not to mention keeping costs down, I would stick to either precious metals mutual funds, which invest in companies that mine and process gold and other precious metals, or gold ETFs, each share of which gives you ownership of a tenth of an ounce of gold held by the fund.

For a list of precious metals funds as well as performance stats and other information, click here. As for gold ETFs, there are currently two available, the iShares Comex Gold Trust and streetTracks Gold.

Frankly, though, I think the strategy you use to invest in gold is ultimately more important than the particular vehicle you use to buy it. Because if you screw that up, you're not likely to make money no matter how you're invested in gold.

_________________________

More recent Ask the Expert columns:

On the path to early retirement

Clearing up Roth IRA confusion Top of page

YOUR E-MAIL ALERTS
Follow the news that matters to you. Create your own alert to be notified on topics you're interested in.

Or, visit Popular Alerts for suggestions.
Manage alerts | What is this?

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.