MAY 28, 2010, 2:18 A.M. ET.

Should You Buy Gold?

By SHEFALI ANAND

Gold is once again near an all-time high, thanks to nervousness about the global economy.

But where is it headed from here? And is it a good investment for individuals like you and me over the next 10 to 20 years?

A store employee arranges gold necklaces at a jewelry shop in Mumbai, India, on May 14, 2010.
.If you ask my mother, it is. She agrees with a commonly held belief in India that the gold price "will always go up." Her evidence: gold cost 330 rupees ($7) per 10 grams in May 1973 around the time of her wedding and now it costs around 18,800 rupees ($410).

Those are impressive numbers because in absolute terms the gold price has increased nearly 57 times. But some calculation shows that over this 37-year period, gold's average annual return is only 11.5%. Even the price of milk has gone up almost by that much over this period; by my mother's recollection it was one rupee per kilo in 1973 and it's at least 24 to 30 rupees now in Delhi, an average increase of 9% to 10% every year. Her gold investment has barely kept up with inflation!

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.The last decade has been a particularly good one for gold, for several reasons. Due to the U.S. economic collapse, large investors have been buying gold lately because they believe that even if the world economy continues to suffer, gold will have some value. Meanwhile, developing countries, which have become richer in this decade, have been buying gold to store their riches.

For the 10 year-period through Tuesday, the gold price has gained an average of 16% every year. But there are no guarantees that the returns of the last decade can be repeated in the next 10 years. A look at its history, and a comparison with other types of investments, shows it to be a less good deal.

Gold has done only a little better than stocks, for instance. Over the past 10 years, the Bombay Stock Exchange's 30-share Sensitive Index or Sensex has gained at least 15% every year (this does not include dividends paid on stocks, which would increase the total return further).

Over the longer term, gold has fared worse. It gained only 6% annually over the past 20 years, while the Sensex went up on average 16% every year, according to data from Dow Jones Market Data Group.

Like my mother, there is no dearth of gold bulls in this world.

Many money managers and analysts think the world economy will remain unstable for a while, keeping the gold price high. They believe that governments like China's will keep adding to their gold holdings over the next several years, which will further push up its price.

The reasons seem pretty valid and they might turn out to be true. Or, they might not.

For you or me, or for any "market expert" to say decisively whether gold prices will go up over the next 10 years is akin to claiming we have a crystal ball in which we can accurately see the future.

That's because the price of gold is primarily determined by people's perception of its value; not necessarily because of demand and supply. This is rare to gold.

Consider another commodity, say sugar. Its price was at a record high earlier this year, because not enough of it was being produced to meet the demand from consumers. In recent months, its supply has increased and so prices have come down.

Gold production, on the other hand, has remained more or less the same, and its demand has actually fallen because of its high price.

Total gold demand fell by 25% in the first quarter of 2010 compared with a year earlier, according to the World Gold Council. Still, gold prices have been moving all over the place. Its price is being determined by financial investors, who own a large part of the world's gold reserves but have no end use for it. If all of these investors think that the price of gold will go up, and they buy, they end up pushing its price higher.


Bloomberg News

Gold bangles are displayed at a jewelry shop in Mumbai, India.
.These "sentiments" are triggered by world events and news, and they can easily turn the other way without you or I knowing when and how that happened.

"Physical demand is only part of the story," says Naveen Mathur, associate director of commodities and currencies at Angel Broking Ltd. "More of the price of gold is driven by what's happening globally," he says.

Billy Wang, vice president of research at India Infoline's IIFL (Asia) Pte Ltd., says the price of gold has been closely tied to the U.S. dollar—as the dollar depreciated, gold increased. The dollar's movements, in turn, are largely dependent on U.S. monetary policy.

While large investors and central governments may have the resources to keep track of all these factors that impact gold, and thus buy or sell, individual investors should ideally take a longer-term view.

Unlike popular (and my mother's) belief, there is a history of gold's price falling.

During times of prosperity and growth in the world, gold prices fell. Between January 1980 and January 1990, gold lost 28% of its value. Over the subsequent 10 years through January 2000, gold fell an additional 27%.

Now, after its sharp increase over the past decade, even gold bulls are skeptical about its potential as a high-return investment.

Mr. Mathur of Angel believes that large investors around the world will keep buying gold this year to reduce risk in their portfolios (as compared to stocks) and so gold prices will likely be higher at the end of this year. However, "percentage returns would not be as great as what we've seen in the last couple of years," says Mr. Mathur.

Given that individuals don't earn any interest or dividend on gold, Mr. Wang of IIFL thinks that gold is best suited as an insurance policy rather than an investment.

Like an insurance policy, gold is not of much use in normal circumstances but it becomes extremely valuable when some major event happens because it can be resold even in time of disaster. In other words, you may not make money on it but it will help you get some money even if there's a war or there's a breakdown in government.

It should ideally be around 5% of your overall portfolio.

"If you are in India and China, put some faith into your countries' ability to generate wealth," says Mr. Wang. In other words, buy assets that will grow as the economies grow, such as stocks of companies.

Write to Shefali Anand at shefali.anand@wsj.com

http://online.wsj.com/article/SB1000142 ... WORDS=Gold