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How many of you have heard the argument that the United States dollar is a fiat currency that is destined to fall in value as a consequence of inflation created by the Fed, and you should therefore buy gold to hedge against this "inevitable" loss of purchasing power? While it's true that gold will nominally increase in value over time to roughly correspond with inflation (you can view this chart here to check out historical gold price dating back to 1833), a comparison between gold and the United States dollar is incomplete. If you assume we will live in a world of inflation going forward, then anything that stores will value will be a better alternative.

But since I'm not contemplating making investments in the United States dollar, I am much more concerned about knowing this: compared to the dollar, will gold do better than the stocks of American blue-chip companies? There, the answer gets much more complicated.

Below I have listed the earnings growth and dividend growth for many of the most widely held blue-chips such as Coca-Cola (KO), Johnson & Johnson (JNJ), Procter & Gamble (PG), PepsiCo (PEP) and Colgate-Palmolive (CL). I included Exxon Mobil (XOM) and Chevron (CVX) to demonstrate the business growth of commodities businesses, which are in a way another inflation hedge that gold can be measured against. I also included General Electric (GE) and Wells Fargo (WFC) because both companies were the types of companies bought by conservative investors ten years ago without the benefit of hindsight.

(click to enlarge)

According to the Inflation Data website, the United States has experienced a total of 28% inflation since 2002, for a rate of around 3%. What is interesting about this collecting of blue-chips is that, with the exception of General Electric, all of these companies grew earnings by at least 6% annually over that time frame, and with the exception of Wells Fargo, grew dividends by at least that amount as well. A couple of the better performing blue chips on this list grew earnings and dividends by 9% or better annually over that time frame.

I find that quite interesting. Many of these no-brainer blue chip stocks were able to grow earnings by double or triple the inflation rate, and by returning some of that growth to shareholders in the form of cash dividends, they were able to receive 2x or 3x the purchasing power on cold hard cash by receiving dividend checks in the mail. Because the companies listed above are productive assets, they generally can offset the declining value of the US dollar by increasing profits at a rate that is noticeably above inflation.

Yes, money can be made trading gold. But as this chart shows, if someone bought gold in December 1979, the price growth that occurred between then and 2011 did not outstrip inflation. Essentially, gold investors since 1979 maintained the same purchasing power that they had in 1979, but did not grow it. Because gold is a non-productive asset, it is only worth what someone else is willing to pay for it. While this is true with common stocks as well, the growth in profitability of the firms listed above puts a floor of sorts on the stock price. When Coca-Cola has $11 billion in profits that are getting returned to investors this year, a certain threshold gets created below which the shares will not trade (although reasonable minds will disagree about the exact marking spot of this floor). While the floor price of blue chip stocks likely grows with each year that profits increase, the price of gold does not benefit in this manner because it does not produce anything.

Furthermore, the only way that an investor may benefit from gold ownership is by creating a substantial difference between the price he pays for gold and the price he sells the gold for. The blue-chip investor, meanwhile, is much less reliant on creating a difference between the purchase price and the sell price. Because the blue-chip investor can receive cash dividend increases every year at a rate that is likely above inflation, he is able to enjoy a material benefit while he owns the asset. The gold investor can only achieve a material benefit by selling the asset.

The best argument for holding gold over blue-chip stocks is that gold cannot go bankrupt. Gold can't pay management too much, dilute shareholders, make stupid acquisitions, and reduce an investment to $0. It's highly unlikely that gold will ever fall to $0. The downside risk on a company specific level is likely greater for a particular blue-chip stock than gold as a whole. But when you expand the comparison so that it becomes "the best blue-chip stocks" (such as those listed above) vs. gold, then the benefits of owning gold becomes much less apparent. For accepting the small risk that the basket of blue chips listed above may go bankrupt, you receive a high likelihood chance to increase double or triple your purchasing power relative to the inflation rate each year. A purchase of gold does not come with this commensurate likelihood.

I can fully understand why someone would prefer holding gold to cash over long periods of time, but I think the appeal of gold diminishes greatly when it is compared to a basket of high-quality blue chip stocks like Coca-Cola and Johnson & Johnson. High-quality blue chips tend to grow earnings by a rate noticeably higher than inflation each year, and they allow the owners of the business to benefit from this fact by receiving dividend checks that increase purchasing power each year. Because gold does not produce anything, it lacks the ability to grow in the manner that a blue-chip stock does. You generally have to buy low and sell high to play gold well, but blue-chip stocks can reward you with raises in purchasing power each year without making investors worrying about the sell price of the security because the earnings and dividend growth benefits can continue indefinitely.

Source: Why Blue Chips Should Beat Gold