Gold Bankrupted Spain — and Could Bankrupt You

There's that old yarn about how those who forget history are doomed to repeat
it. Rabid fans of gold would do well to remember this because gold bubbles have
bankrupted many investors in the past and in fact have resulted in the fall of
empires, not just investment bankers. Consider that at the dawn of the 16 th
century, Spain was one of Europe's wealthiest nations. By 1598, it essentially
was bankrupt. Why? Because despite the looting of the "New World" and a
horde of new gold flowing into the treasury, it was spending well beyond its
means because of imperialist policies and costly wars. Beyond that, the supposed
riches taken from South America created a false sense of security, and Spain
failed to focus on any industry other than trade in precious metals. That
resulted to widespread inflation that took a deep toll on Spanish commoners.
There are a host of lessons to be learned here, and I expect the comment section
at the end of this article will carry on a spirited debate about the prospect of
America's current debts, costly wars and failure to create 21 st century
industries and jobs. But the "investable" idea I want to focus on is much
simpler: That the illusion of wealth sometimes can be more destructive than the
reality of austerity. Or put another way, it's the same psychology that
plagues many lottery winners. Otherwise level-headed folks turn into
spendthrifts or lose all common sense with the influx of a few million bucks.
Gold has a way of doing that to people these days. We see headlines trumpeting
gold touching "records" above $1,900 though the true inflation-adjusted
high of gold was its 1980 peak of $850, which is about $2,400 in todays dollars.
We see folks touting the fact that gold is up more than 50% in the past 12
months but not that the precious metal is significantly above moving averages ,
and that going "parabolic" might just mean gold is grossly overbought. We
hear goldbugs tout how the metal is truly an "outsider" investment that
isn't subject to the shenanigans of Wall Street or banks. But the SPDR Gold
Trust (NYSE: GLD ) is now the largest exchange-traded fund , surpassing the SPDR
S&P 500 ETF (NYSE: SPY ) in assets. Sounds pretty mainstream to me. We hear
myths about how gold has no correlation to the stock market, and thus is a great
contrarian investment. In fact, if you look at the past 12 months, gold is very
much correlated to the stock market it performs almost exactly in inverse.
While it's fair to say gold is a way to play the other side of the trade,
it's not necessarily a way to diversify your portfolio beyond the equity
market. All this is not to say that gold is useless in your portfolio, or even
to say that gold will not keep rising in the months and years ahead. But please,
know your history. When the gold bubble popped in the early 1980s, investors who
rode the precious metal all the way down lost more than 50% in the flop. And
while gold wasn't the only reason the Spanish empire fell, the illusion of
wealth certainly convinced leaders that everything was just fine when it was
anything but. Gold is very volatile and has the ability to destroy your
retirement funds, as well as build them up. Like all investments, you must think
rationally about the risks and rewards of the precious metal and just how much
of a role it will play in your portfolio. Jeff Reeves is editor of
InvestorPlace.com. As of this writing, he did not own a position in any of the
stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of
InvestorPlace on Facebook .