Learn From the Gold Debacle

The recent sharp decline in the price of gold is an opportunity to learn from the well-known quote attributed to George Santayana that "those who cannot learn from history are doomed to repeat it."

At the outset, let me state that I have no idea whether the price of gold will continue to decline or will reach new highs. Neither does anyone else. That's precisely my point.

In October, Morgan Stanley analysts Peter Richardson and Joel Crane opined that "Central bank policies ensure conditions remain favorable for continued price appreciation for both gold and its cheaper proxy, silver." The bank expected gold to average $1,683 an ounce in 2012 and increase to $1,853 in 2013.

Last week, with no apology, Morgan Stanley lowered its forecast for gold. It cut its 2013 target to $1,409 an ounce in a new report authored by -- you guessed it -- Mr. Richardson and Mr. Crane.

According to Yahoo! Finance, gold opened on July 1 at $1,234.70 an ounce.

There has been no end to faulty predictions about the price of gold. You can find a summary of them here. Perhaps the most notable one was a very confident 2009 prediction from Peter Schiff, who is known for his doom and gloom views: "I don't think it's just possible -- it is highly likely gold will hit $5,000."

Investors who bought gold based on these predictions have paid dearly. The price of gold is down 25 percent in 2013. If you invested in the shares of gold-mining companies, hoping to capitalize on the projected increase in gold prices, you fared even worse. According to an article in Forbes, shares of companies in this sector are down a staggering 50 percent in 2013.

Instead of learning from this history, we are repeating it. Investors are buffeted with contrary recommendations from credible sources about whether to buy or sell gold.

In April, Goldman Sachs issued a note to its clients advising them to get out of gold.

Also in April, an article in Forbes advised investors to watch for a "selling climax" in gold that could be a clue "that the bottom has arrived." The article suggested a price drop in the $1,250-$1,300 range might be an indication that the bears will "tire." Presumably, we are now at that point.

In an article dated July 1, Barry Ritholtz makes the case for a "counter-trend rally." Mr. Ritholtz disclaims any ability to make predictions about "where Gold will or will not go," but then lays out two possible scenarios based on "weekly and monthly charts."

Mr. Ritholtz has impressive credentials, including being named as one of the "15 Most Important Economic Journalists" in the United States. Given his background, I suspect many investors will rely on his assessment of the possibility of a "counter-trend rally."

Clearly, some of those making predictions will turn out to be right, but I would caution investors against relying on the analysis of anyone concerning the direction of the markets, much less the price of any commodity like gold. There is no way to prospectively identify which predictions will be correct. The risk of relying on these predictions is more like speculation and not investing. The expected return of speculation is zero, or less when you consider transaction costs.

Fortunately, there's a better way to invest. It doesn't rely on financial astrology. Instead, guessing about the future is replaced with deciding how much of your portfolio to allocate to a globally diversified portfolio of small, large, value and growth stocks, and how to use fixed income to mitigate risk. Replacing speculation with science is the only responsible and intelligent way to invest.

While those who made poor predictions in the past are undeterred and unapologetic, that doesn't mean you should fall in line and not learn from history.

Dan Solin is the director of investor advocacy for The BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.