When the going gets tough, the smart money hedges its bets. Concerns over global unrest; cyber-terrorism; crises in the equity, credit or currency markets—pretty much anything that smacks of looming systemic collapse is enough to prompt serious investors to tighten the reins on their investment capital and position at least a small portion of that wealth in time-honored stores of value, such as physical gold and silver (as opposed to mining stocks, ETFs, etc.).
Historically, gold has been the go-to currency hedge for people who suddenly found themselves worried about the solvency of their country’s fiat currency. The yellow metal made sense because it has an agreed upon current market value, or spot price, and a long history of serving as a means of exchange or trade.
But gold bullion is heavy and difficult to store or transport. It’s also difficult to exchange during minor transactions. And, in the event of a major meltdown, governments have been known to confiscate people’s gold, which happened in the U.S. under FDR in 1933.
While it’s extremely difficult to predict if world governments would follow the same playbook in the event of future economic collapses, that possibility, however remote, does exist.
For all these reasons, investors are tempted to look at other tangible, sparkly commodities—such as diamonds—as a substitute for physical gold. But they shouldn’t.
The Case for Owning Gold
With the price of gold currently hovering near its five-year low, some analysts regard it as a worthwhile speculation. Their thinking is that the price has fallen so far so fast that most of the risk has been stomped out of the commodity. In other words, it has nowhere to go but up.
While that may be true, when it comes to gold, it’s usually better to think of it as a currency rather than an investment. That’s not to say fortunes haven’t been made speculating on gold. But as a general rule, it’s more in line with currencies than other investment vehicles, such as stocks or bonds.
So, physical gold is what investors turn to when they lose faith in currencies that are backed by nothing more than the promise of the issuing government in question. It’s a hedge, a way to offset risk. Gold serves well in this regard because its global supply is relatively finite and its relative purchasing power historically has remained stable during inflationary periods.
That said, for most individual investors, physical gold should be viewed as a long-term investment, not something to jump in and out of as the day-to-day price swings.
Think of it this way: in your portfolio, you probably have your “safe” investments for things like retirement or a child’s college fund. You may also have your “play money,” a much smaller percentage of your wealth allocated to special opportunities, such as that hot biotech stock you’ve been tracking, or an options trading strategy you’ve wanted to try.
Physical gold is something you’d invest in apart from your portfolio, over time. Something you’d accumulate—perhaps on a dollar-cost averaging basis, where you’re buying a fixed dollar amount of gold on a regular schedule, regardless of its price—so you’ll have it “just in case” you ever need it. It certainly won’t hurt you to have some on hand, but you’re not betting the ranch on it in hopes of making your fortune. It’s a worst-case-scenario play; the ultimate rainy day fund.
Diamonds Are Forever … Except For Investors
Diamonds are beautiful, lasting and arguably as alluring as gold bullion. (In fairness, both are a sight to behold up-close.) But unless you’re fleeing a war-torn country and need a store of value that’s light, portable and doesn’t set off the metal detectors, diamonds don’t seem to offer much upside—and the downside risk can be significant.
In fact, prices of top-quality stones have cratered by as much as 80 percent in real, inflation-adjusted terms over the past 30 years, according to the Rapaport Diamond Index, an industry benchmark.
“Even before looking at all the transaction costs, diamonds have proven an absolutely disastrous investment for decades,” the Wall Street Journal reports. “… Even if you set aside the short-lived but massive price bubble back in 1980—around the time of a similar bubble in gold and many other commodities—the results have still been abysmal.”
Equally important, diamonds fail the basic criteria of any good investment, according to Clinton Beck, president of Beck Gold and Diamond Brokers.
For starters, diamonds are only a good investment if you can buy low and sell high. But most companies that sell investment grade diamonds mark them up as much as a jeweler would mark up a piece of jewelry (say, 50 percent)—so it’s very unlikely you’d see a profit if and when you attempted to liquidate the stone. By comparison, a similar investment in gold bullion would only require the investor to pay a small commission of around five percent.
“The time needed for the investor to turn a profit with diamonds is huge,” writes Beck. “The figures I have seen on websites promising huge returns are pure speculation and questionable. Diamonds have never moved in history anywhere near what is being speculated. All the experts I have talked to agree that it is pure hype and speculation with no basis in reality.”
Then there’s the cost of insuring your diamonds, which isn’t cheap and further erodes your chances for profitability.
But perhaps the biggest obstacle to successfully investing in diamonds is the lack of liquidity. Unlike gold, which has a spot price and an established market, diamonds offer no market for an investor to easily access.
If you want to sell, you pretty much have three options:
- Selling to a diamond broker, who will only be interested in buying below wholesale, so he can turn around and sell it at wholesale to make a small profit
- Selling at auction, which will hit you with a commission fee that’s usually around 25 percent
- Selling to a private investor, which is somewhere between very difficult and impossible for an average investor to do.
“The only people that may be able to turn a profit (on diamonds) are the investor’s grandchildren,” adds Beck.
Although the market value of diamonds may take off again during times of high inflation and negative real interest rates (conditions similar to the 1970s), diamonds are a risky investment best left to professional diamond dealers. They’re certainly no substitute for gold.
There are many wealth protection strategies available to savvy investors. If you’re considering shifting a portion of your wealth into tangible assets for peace of mind, the case for gold is stronger for all of the reasons outlined above.
You can learn more about this approach at our next Precious Metals Investing Summit.