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What Are The Risks of Investing in Gold?

Gold has typically been considered a safe haven asset among all other investment vehicles. Even though the value of gold might be more stable than other investment assets, there are some unique risks involved with investing in gold. The most common risks of gold investing are these:

The primary risk of investing in gold is the devaluation of this precious metal and a significant drop in market price. Next, security and storage of physical gold is an additional concern, as well as the opportunity cost of not having employed this capital in a different investment vehicle such as the stock market.

In this article, I will highlight the downsides of investing in gold, whether gold is a high-risk investment, and go over the three main risks of investing in gold.

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Why Gold is a Speculative Instrument

First of all, it is important to clarify that an investment in gold is not actually an investment but speculation. The difference between investing and speculating is that an investment deploys capital to a productive asset that, upon thorough examination, promises a steady return and safety of capital.

Speculation, on the other hand, is characterized by the fact that the asset does not produce anything on its own, i.e., dividends in the case of stocks, and the only way for the investor to exit the investment is by selling the asset to another investor. Thus, gold fits the definition of a speculative instrument instead of an investment.

However, that said, gold can have some uses in a well-diversified portfolio or mitigate drawdown risk. There are several factors that can make gold investing a high-risk activity.

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Is Gold a High-Risk Investment?

Over the past centuries, gold has been used extensively as a means of trading and as a store of value by millions of people around the world. However, since the invention of money and liquid currency, gold has lost at least one of its main functions.

A high-risk investment can be characterized by the fact that all of your invested capital is at risk and has the possibility of losing all of its value in the market. For this scenario to come true, gold would thus have to drop to zero and liquidate all of your gold holdings.

One reason why gold cannot be considered a high-risk investment, according to this definition, is that there is and always will be an industrial use case for gold. Currently, gold is traded at a premium much above its industrial value, since it is also used as a store of value. It could in theory drop to a price point where it is valued by the industry.

This industrial use of gold provides a base floor price to gold and significantly reduces the risk of gold becoming essentially worthless.

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Risks Associated with Investing in Gold

Devaluation

So what are the main risks of investing in gold besides the previous point? The first risk I would like to talk about is a price change and the devaluation of gold as an investment asset.

As mentioned before, there will always be industrial use for a structurally valuable metal such as gold. However, the devaluation might occur in the fact that it no longer serves as a proper store of value for people. With other digital forms of value storage such as Bitcoin, the role of gold as a store of value might be threatened.

Security and Storage

Another, more obvious risk of acquiring physical gold is the security and storage of that gold. Physical gold has to be stored and protected at a safe and potentially hidden location, and there are costs associated with this storage of gold. On the other hand, this cost and risk can be easily circumvented by not holding physical gold but instead investing in a gold ETF such as GLD.

Opportunity Cost

The third risk is that of opportunity cost, or in other words, the opportunity of investing your capital in a different asset and the divergence in return that has been lost. Compared to an investment in the S&P500 or the total stock market, gold has performed significantly worse.

If you had invested in gold in the 1930s when the price hovered around $60 to $80, you would have experienced about a 20-fold multiplication of value in dollar terms up until today. On the other hand, an investment in the Dow Jones, which traded around 50 to 60 points in the 1930s, would have yielded several orders of magnitude more return as it trades between 14,000 and 16,000 points today.

Thus, compared to an investment in the stock market, it cannot even be said of gold that it is an efficient store of value. The only case for gold can be made in a scenario where all institutions and technology collapse and humanity essentially transitions back to living in primeval societies.


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