Should You Own Gold?

NEW YORK ( TheStreet) -- As a financial adviser, I recommend gold as part of a diversified investment plan. For Baby Boomers I tend to prescribe an extra dose of gold, about 10% and sometimes up to 20%.

Usually, it is not a problem getting investors to accept this prescription -- until the recent gold collapse that gave investors a "stock market crash" feeling.

As a result, I think it's time for investors to change their thinking.

Should gold be skyrocketing?

One very good reason it isn't is because of the bifurcation in the gold market. Specifically, now there are two markets and they are behaving in different ways. Moreover, speculation in one market is negatively impacting upon the other. The two markets I am referring to are the physical market -- gold bars and coins -- and the derivative market consisting of gold ETFs, gold funds, gold options and gold futures.

I interviewed Jim Rickards, lawyer, former investment banker, and the author of "Currency Wars: The Making of the Next Global Crisis," for my radio show, and he was unequivocal about the impacts of speculation through derivative products.

"Leverage gets into the system when people buy gold ETFs on margin, and suddenly there are margin calls because the market takes a hit," he said. "When that happens, like it did recently, the buy and sell decisions are no longer rational."

There are several challenges that come with this bifurcation that were not readily apparent until recently.

First, the number of derivative products betting on gold is now far larger than the gold supply itself. My speculation, and my worry, is that if all of the derivative products that have a claim on physical gold were put to central banks and other depositories, that physical delivery could not be made.

It would be the equivalent of having a cash redemption feature on all U.S. debt, where all the buyers suddenly wanted their money back at 100 cents on the dollar.

Second, the prices in the gold market are rather easy to manipulate in the futures market (See "Not Your Grandfather's Bank Holiday"), and once these prices are manipulated it creates an opportunity to arbitrage between the physical market for bars and coins and the derivative markets such as ETF, futures and options.

The whipsaw in gold demonstrates the powerful effects of the distortion created by these two markets.

For investors, I would not suggest gold has no place in your portfolio. Rickards concurs with my thinking that 10% is appropriate for conservative investors and 20% for aggressive investors. If you are a long-term investor, gold is still a reasonable hedge.

"None of the fundamental reasons to own gold as a tool to preserve wealth have changed," says Rickards. "What happened during the week has only made gold like shopping at Walmart. It's a lot cheaper."

However, the rules of the game have changed, and now the only way I can recommend owning gold for investors is in its physical form, in a vault that you can access.

I could lament on what a sad development this is but there's already enough emotion in the markets clouding judgment and creating losses. For smart investors, the best course of action is to reassess and act accordingly.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.