Of late, you can’t watch cable news for a day without seeing more advertisements about owning gold than you used to see in a year. That should tell you something. Because whenever an “investment” concept or idea gets so hot that it pays vendors to spend hugely increased advertising budgets—to get while the getting is good, as it were—you can be pretty sure that concept is in full-on bubble mode.

You will not have failed to notice that you never see wall-to-wall ads for something which is deeply out of fashion, with its price falling and therefore its long-term potential value increasing sharply. Last March, for example, you saw not one ad trumpeting a “50%-off sale on the great companies in America! Buy now—this sale can’t last!” That would have been (a) true, and therefore (b) a total waste of advertising dollars, as equities were so cheap precisely because they were universally considered an instant, fast-acting carcinogen at that time. That’s why they were such a good buy. Ad dollars are best spent on the easiest sale; the easiest sale is always whatever is most in vogue; in investing, the phrase “in vogue” is always interchangeable with the phrase “too late.”

Gold is quite wildly in vogue these days, as the apocalypse du jour—the next crisis which is sure to envelop us all—is popularly held to be inflation: literally, the depreciation of paper currency, and a concomitant rise in the price of hard assets like precious metals. And, like all possibilities that get spun into cataclysmic certainty in the mainstream media, there is even some basis in fact for this.

The United States, in running unprecedented deficits, does indeed threaten the debasement of the dollar, and in fact the dollar’s trend has been down against the other major world currencies—and against commodities—for some time. What’s astonishing is not this premise, but the conclusion that people draw from it: that because an increase in inflation may happen, it will certainly happen. And that gold—making “new historic highs” every day—is the sure bet to get inflation working for you instead of against you.

There is a certain childlike quality to this “reasoning”—as indeed there is to all investment bubbles. It’s a sweet, logical little story that anyone can understand. And all you have to do in order to subscribe to it is completely to ignore the entirety of the historical record.

Let’s begin with the notion of gold as an inflation hedge. In a very long-term sense, gold has, in fact, been a mildly efficient antidote to the erosion of purchasing power. It is axiomatic that an ounce of gold has historically bought a good men’s suit. It did so in London in 1700 and 1800, and in New York and London in 1900 and 2000. I checked the bespoke suit department at Barney’s here in New York over the Christmas shopping season, and found this relationship to be holding, though just barely.

But the idea that gold has a good record in more recent periods—and that equities have a bad record—is simply ludicrous.

Return with me now to that thrilling day of yesteryear: January 21, 1980—very nearly thirty years to the day before you read this. (You want to start training yourself to think in thirty-year clips, by the way, because that’s about the length of the average two-person American retirement that’s starting around now.) That was the day gold hit its previous bubble peak—its “record new historic high,” as journalism likes to call it—the last time around. It topped out at $850 an ounce.

Now here’s the really fascinating part. If gold had functioned as an efficient inflation hedge in the interim—that is, if its nominal dollar price had risen in lock-step with Consumer Price Index inflation, thereby offsetting it—it would have to be selling today at about $2266 per ounce.

It isn’t. As I write, a few days before Christmas, it’s $1110, and the “all-time record new historic high” of recent headlines was about $100 an ounce higher than it is now. Just to give gold the benefit of the doubt, do you want to call it $1250 an ounce?

Fine. At $1250 an ounce, the real price of gold, adjusted for CPI inflation, has fallen about 45% in the last thirty years. At $1110, of course, it’s down over half. (If you want to perform this calculation for yourself, go to the wonderful website www.measuringworth.com/uscompare. It lets you calculate by calendar year, so I did 1980 through 2008, and then added two percent as a plug number for 2009 CPI inflation.) Classics Illustrated comic books were a far better inflation hedge than that.

As were—hold on to your hat—common stocks. On January 21, 1980, the S&P 500 closed at 112. To have hedged against inflation—to have gone up in lock-step with the CPI, thereby offsetting inflation—the S&P 500 would have needed to rise to a tad more than 300 by year-end 2009. As I write, it’s 1100. That is, the real price of equities, adjusted for CPI inflation, has risen something like three and a half times in the last thirty years.

And of course, equities paid dividends. You had to pay to store gold.

What does any of this prove? Probably nothing, in the sense that the past—and especially any thirty-year clip of the past—doesn’t prove anything about the future. But it is highly suggestive of a couple of important truths. The first is that, if you’re going to invest in something that’s supposed to be a near-perfect inflation hedge, you’d better make real sure that it has, in fact, hedged inflation with some consistent efficiency. And the other is that there’s nothing like buying into investment fads to insure wildly substandard returns for years, and even decades, to come.

Next time you see six different ads for gold in one broadcasting day, these might be two really good things to bear in mind.

© 2010 Nick Murray. All rights reserved. Reprinted by permission.

Stocks, bonds, and cash are fundamental components of an investment portfolio. However, many other investments can be used to try to spice up returns or reduce overall portfolio risk. Socalled alternative assets have become popular in recent years as a way to provide greater diversification.

What is an alternative asset?

The term “alternative asset” is highly flexible; it can mean almost anything whose investment performance is not correlated with that of stocks and bonds. It may include physical assets, such as precious metals, real estate, or commodities. In some cases, geographic regions, such as emerging global markets, are considered alternative assets. Complex or novel investing methods also qualify. For example, hedge funds use techniques that are off-limits for most mutual funds, while private
equity investments rely on skill in selecting and managing specific businesses. Finally, collectibles are included because the value of your investment depends on the unique properties of a specific item as well as general interest in that type of collectible.

Each alternative asset type involves its own unique risks and may not be suitable for all investors. Because of the complexities of these various markets, you would do well to seek expert guidance if you want to include alternative assets in a portfolio.

Hedge funds

Hedge funds are private investment vehicles that manage money for institutions and wealthy individuals. They generally are organized as limited partnerships, with the fund managers as general partners and the investors as limited partners. The general partner may receive a percentage of the assets, fees based on performance, or both.

Hedge funds originally derived their name from their ability to hedge against a market downturn by selling short. Though they may invest in stocks and bonds, hedge funds are considered an alternative asset class because of their unique, proprietary investing strategies, which may include pairs trading, long-short strategies, and use of leverage and derivatives. Participation in hedge funds is typically limited to “accredited investors,” who must meet SEC-mandated high levels of net worth and ongoing income (individual funds also usually require very high minimum investments).

Private equity/venture capital

Like stock shares, private equity and venture capital represent an ownership interest in one or more companies. However, unlike stocks, private equity investments are not listed or traded on a public market or exchange, and private equity firms often are involved directly with management of the businesses in which they invest.

Private equity often requires a long-term focus. Investments may take years to produce any meaningful cash flow (if indeed they ever do); many funds have 10-year time horizons. Like hedge funds, private equity also typically requires a large investment and is available only to investors who meet high SEC net worth and income requirements.

Real estate

You may make either direct or indirect investments in buildings–either commercial or residential–and/ or land. Direct investment involves the purchase, improvement, and/or rental of property; indirect investments are made through an entity that invests in property, such as a real estate investment trust (REIT). Real estate not only has a relatively low correlation with the behavior of the stock market, but also is often viewed as a hedge against inflation.

Precious metals

Investors have traditionally purchased precious metals because they believe that gold, silver, and platinum provide security in times of economic and social upheaval. Gold, for instance, has historically been seen as an alternative to paper currency and therefore
may help hedge against inflation and currency fluctuations. As a result, gold prices often rise when investors are worried that the dollar is losing value, though prices can fall just as quickly. There are many ways to invest in precious metals. In addition to buying bullion or coins, you can invest in futures, shares of mining companies, sector funds, and exchange-traded funds (ETFs).

Natural resources

Direct investments in natural resources, such as timber, oil, or natural gas, can be done through limited partnerships that provide income from the resources produced. In some cases, such as timber, the resource replenishes itself; in other cases, such as oil or natural gas, it may be depleted over time. Timberland also may be converted for use as a real estate development.

Commodities and financial futures

Commodities are physical substances that are fundamental to creating other products or to commerce generally. Commodities are basically indistinguishable from one another. Examples include oil and natural gas; agricultural products such as corn, wheat, and soybeans; livestock such as cattle and hogs; and metals such as copper and zinc.

Commodities are typically traded through futures contracts, which promise delivery on a certain date at a specified price. Futures contracts also are available for financial instruments, such as a security, a stock index, or a currency. Though the futures market was created to facilitate trading among companies that produce, own, or use commodities in their businesses, futures contracts also are bought and sold as investments in themselves, and some mutual funds and ETFs are based on futures indexes.

Futures allow an investor to leverage a relatively small amount of capital. However, they are highly speculative, and that leverage also magnifies the potential loss if the market does not behave as expected.

Art, antiques, gems, and collectibles

Some investors are drawn to these because art, antiques, gems, and other collectibles may retain their value or even appreciate as inflation rises. However, those values can be unpredictable because they are affected by supply and demand, economic conditions, and the quality of an individual piece or collection.

Why invest in alternative asset classes?

Part of sound portfolio management is diversifying investments so that if one type of investment is performing poorly, another may be doing well. As previously indicated, returns on some alternative investments are based on factors unique to a specific investment. Also, the asset class as a whole may behave differently from stocks or bonds.

An alternative asset’s lack of correlation with other types of investments gives it potential to increase or stabilize a portfolio’s return. As a result, alternative assets can complement more traditional asset classes and provide an additional layer of diversification for money that is not part of your core portfolio, though diversification cannot guarantee a profit or ensure against a loss.

Tradeoffs you need to understand

Alternative assets can be less liquid than stock or bonds. Depending on the investment, there may be restrictions on when you can sell, and you may or may not be able to find a buyer. Performance, values, and risks may be difficult to research and assess accurately. Also, you may not be eligible for direct investment in hedge funds or private equity. The unique properties of alternative asset classes also mean that they can involve a high degree of risk. Because some are subject to less regulation than other investments, there may be fewer constraints to prevent potential manipulation or to limit risk from highly concentrated positions in a single investment. Finally, hard assets, such as gold bullion, may involve special concerns, such as storage and insurance, while natural resources and commodities can suffer from unusual weather or natural disasters. A financial professional can advise you on whether alternative assets have a role in your portfolio, and which types might be appropriate for you.

Copyright 2006-2010 Forefield Inc. All rights reserved.

Securities and advisory services offered through Mutual of Omaha Investor Services, Mutual of Omaha Plaza, Omaha, NE 68175-1020. The information provided is general in nature. It has been obtained from sources believed to be reliable, but no warranty is made as to its accuracy, timeliness or completeness. The information is not intended, and should not be construed as legal, tax or investment advice, or a legal opinion. Consult with your legal, tax or investment professional before taking any action based on this information. This information is not an offer to buy or sell any security. Past performance is not a guarantee or prediction of future returns. Potential investors should review all prospectuses before investing. There is no contractual relationship between Family Wealth Management Advisory,LLC and Mutual of Omaha Investor Services