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Happy long weekend grasshopper!

I’ll make my intro short and sweet for once, as here in the U.S. we are embarking on a three-day holiday weekend and I don’t want to come between you and your BBQ fun!

Let’s jump right in…

First, Maile asks,

Last week (July 23 – 27), I purchased more gold with the anticipation of this week’s announcement on the federal stimulus. Gold went up, I thought I should get it before it goes up further. And then today (August 1st), it went down. Ah well, -$20 per oz isn’t that bad, hopefully in the long run it will pay off. I’ve spent my big sum (although it’s small compared to most) that I had available, so I’m either going to have to buy silver in increments going forward or save up for more gold.

Hi Maile! First, congratulations on taking action—that is the most important first step you can take. You will learn so much more by doing than you ever will simply by reading, so I am very happy for you!

The spot price of gold ranged from $1572 – $1618 the week of July 23 – 27, and assuming you were on the high end of that (because you mention losing $20 per ounce when it dropped to $1599 on August 1st) you are probably still quite happy today because gold is trading at $1690 as I write this, so you are up $70 or 4.3% in one month alone…not too shabby!   🙂

Quick Detour…Investor Psychology

But I want to caution you (and everyone reading)…

When I read sentences like, “gold went up, I thought I should get it before it goes up further”, huge red flags wave in front of me (and I hope they do in front of you, too!).

This is typical investor psychology that we all must guard against (buying when something has gone up…) but it is so difficult to put into practice—yours truly made the very same mistake early on with silver and had to average down for almost a year when the price dropped after I bought it!

There is just something about human psychology that makes us want to chase winners. We all want to be on the winning team and buy the “winning” stock (or metal or commodity), but there is absolutely nothing wrong with waiting for the next dip (or even “the next big thing” if the “dip” never comes) or with averaging into your purchases.

I do not mean this as a comment to where gold is currently—I believe it still has a lot of room left to rise (and given our current political-economic situation I frankly can’t see how it cannot rise over the long-term, short-term pauses notwithstanding), but if you look at the chart of its bull run over the past decade, you can see we are definitely not at the very beginning when gold was cheap….we are climbing the “wall of worry”.

Historical Gold Prices Chart

$GOLD (daily) - stockcharts.com

And that wall of worry is made up of hundreds of little dips and rises.

It’s impossible to time (although technical charts can help and perhaps some incredibly wealthy genius somewhere has figured it out…if so I wish he would share his secret with me!), but ideally you want to “buy the dips” (or if you prefer, its more vulgar but funny cousin, “BTFD”).

Of course, this is obviously much easier to theorize than it is to implement in practice!

It helps to look at past history so you can get a better sense of where we are now.

By looking at the chart, you can see that even if you had bought “at the tops” (or “interim tops” as they say in financial parlance) you would still be a happy camper now (except for the most recent $1900 and $1784 ones)…provided you didn’t panic and sell on the dips.

So, as long as you believe in the fundamental reasons for owning gold and believe that this giant uptrend will continue (I do…), you’ll be fine even buying the interim “tops”, as long as you don’t panic and sell when those interim tops correct.

Realize that if you had bought at say $1004 in mid-2008 and then weathered the storm down to $705 in 2009, though, that would probably have been an extremely emotional year for you, filled with sleepless nights!

I have several sophisticated investor friends who had bought much earlier, but who were in leveraged gold futures and had to keep meeting margin call after margin call during that painful drop, right in the middle of this huge bull run… not a “fun” time to be sure!

I’m spending so much time detouring on this investor psychology because it is so important and yet so hard, and now with your $20 drop you have had the teensiest tiniest taste of it. (A $20 drop from $1600 is a 1.25% drop…barely a blip in the volatile gold market, but it’s questions like these that will help you decide if you will use trailing stops for your gold and if so at what level, or whether you are buying it for “insurance”).

You have the right mindset for someone who believes in the fundamental reason of why they bought gold in the first place, “ah well, I suppose $20 per oz isn’t that bad, hopefully in the long run it will pay off”…but imagine it dropping another $100 (not at all uncommon in a typical gold bull market correction), and just prepare yourself for the fact that may happen…how will you react? What will you do?

I ask you to think about this now, before it happens, so that you are prepared:

“Under duress, we do not rise to our expectations – we fall to the level of our training.” — Bruce Lee

The only problem with spending your “big sum” that you had allocated to gold is that you cannot average down (unless you have new money coming in that you allocate to future purchases.) For example, if Bernanke announces “no more QE!” and all markets tumble (whether or not they should is another discussion…), you cannot buy more at a lower price.

This is not directed at you personally, by the way…I’m just using your question as an opportunity to talk about why it is great to always have some cash on hand and how important it is to thoroughly think through all of your investment decisions so that you make them as logically (and unemotionally) as possible (because I know from experience, it is difficult!).

OK, sorry for the detour…back to your original question!   🙂

Is it better to save cash to get gold? Or should an investor buy silver and then at one point sell silver to buy gold?

There is no one-size-fits-all answer to this…it is a matter of personal preference, and highly dependent on your beliefs about the future of our economy and your own personal investment situation.

(I don’t mean to give you a “non-answer”, but there is no way I can answer that without knowing a lot about your personal financial situation, which I am not licensed to do so…I’m sorry!)

You probably already understand the major differences between gold and silver (gold is much more expensive than silver, less volatile than silver, and has few if any industrial applications).

Because of this last difference, the “industrial applications”, silver tends to be more dependent on the health of the overall economy and is more affected by economic slowdowns than is gold.

However, silver is also a monetary metal like gold. It has been used as money, just like gold, since the dawn of time.

Speaking generally, silver is more volatile, less costly, and in shorter supply than gold, and theoretically if we do have some sort of fiat monetary system collapse and investors have to choose between gold and silver, many might choose silver simply because gold is out of reach (at over $1600 for one ounce, vs. $31 / oz. for silver, although you can find fractional ounce gold coins).

Some also believe that silver is undervalued relative to gold because of the historic gold-to-silver ratio, which is currently at 53:1 but historically has hovered at 16:1. The ratio tells you how many ounces of silver you would need to exchange to buy an ounce of gold, so at today’s prices, that’s $1691.60 / $31.74 = 53.

If that ratio reverts to its average (and there is a little debate over exactly what that “average” is, but most people say 16:1), or even to half of its average, around 30:1, either silver needs to get a lot more expensive or gold needs to get a lot cheaper.

Some gold-silver ratio purists believe that when the ratio is this skewed, silver is undervalued relative to gold so you should buy silver and exchange it for gold when the ratio tightens.

And of course, this being Kung Fu Finance, I leave the final decision in your more-than-capable hands! I personally have both gold and silver and find that both have a place in my portfolio.

When should I sell?

Great question!

(Actually, I learned in media training this week that you are never supposed to say “great question”!) But never being one to always follow directions…great question!   🙂

This is a great question because many “investors” rush to buy gold or silver because “it seems like a smart thing to do”, or because their advisor recommended it, but they have no understanding of the underlying economics or fundamentals.

If you are buying gold as an investment, and not as a legacy for your future grandchildren or as insurance, then the time will come when you will want to sell your gold.

Typically, this occurs when real interest rates rise, because gold does not pay interest. Currently, interest rates are abysmally low, but if they should rise in the future you may want to think about selling.

Alternatively, if gold has risen tremendously, maybe we’ve gone through high inflation and interest rates haven’t been able to keep up, but you notice that you can buy a lot of real estate (or other asset) with your gold because it is relatively cheap…that’s another great indicator.

And of course you can also check out your favorite mainstream magazine for a contrary indication…typically when they proclaim “Gold is God!” or something equally absurd, it will probably be time to sell:

Time Magazine Home Sweet Home

2006...was this a good time to buy a house?

There are other indicators, too…you can look at the behavior of central banks (are they buying or selling?) and of course at the supply / demand fundamentals and the creditworthiness of our governments. Currently, though, those all point to gold being a strong buy!   🙂

You featured a wonderful article on fear, and I feel as if I’m a classic example of why an investor never invested other than in their 401K. Fear. And quite frankly, I just let my finance guy tell me what to do and I just nod and say “ok”. I KNOW… lame. But when you are dealing with a subject matter that is waaaaay beyond your comprehension, it’s the easiest thing to do.

Yes, you are not alone, I completely “get it”, having been there myself, and that’s the main reason why I started Kung Fu Finance!

You are NOT lame, you are NORMAL—none of us are taught about investing or money management in school and we have to venture out and figure it all out for ourselves!

Hopefully we here at Kung Fu Finance can help to demystify finance and take some of the fear away so that you can be a more educated, successful, “smart money” investor!

Congratulations on taking action! You have definitely earned your white belt!   🙂

That’s all for today, as it is time to go get your weekend on!

Please let me know what you think about these questions and answers in the comments—I love hearing from you!

To your financial success,
— Kung Fu Girl