Does Gold Beat the DJIA? It Depends

Gold as a store of value

I’m not a gold bug. I believe gold’s use as an investment and store of value is a historical artifact not well suited to the modern era. When sailing ships ruled the seas it may have been a fine store of value but when spaceships rule the skies it feels, well, a bit leaden. But, still, in the current environment the question needs to be asked: “does gold still have investment value or has it become the fool’s emporium?”

It is exceedingly tedious to sift through the competing and often repetitive claims of gold’s investment value or lack thereof. Attempts at discussion often devolve, and rapidly so, into emotional arguments emanating from rigid positions of gold owner versus non-owner. Such arguments are hardly a useful insight into gold’s value as an investment and thus as a store of value.

The thought occurred to me that if gold was indeed the best investment vehicle and store of value then it ought to handily outperform other investment vehicles over extended periods of time. On that premise I determined to compare the long term spot price of gold versus the long term Dow Jones Industrial Average (DJIA). Such a head to head comparison might be able to determine the relative value of either investment vehicle as a long term store of value. In this process I arbitrarily assume that the better investment vehicle is therefore, the better store of value.

Of course, if gold or the DJIA does not provide a net positive return, then it fails as an investment and also as a store of value. Thus we need to first determine if either vehicle provides a long term positive return. If so, then we can compare those returns to determine which vehicle is better. So, does either provide a positive return? Which is the better investment: gold or the DJIA?

It depends

As is too often the case the answers to both questions are disappointing. Do gold and the DJIA provide a positive long term return? It depends. Which is the better investment? It depends. What do these answers depend upon? They both depend upon the time period selected. Pick one time period and neither is positive. Pick another and both are positive. Pick a third time period and gold handily outperforms the DJIA. Pick a fourth time period and the DJIA buries gold. Let’s take a closer look to better understand the importance of the time period in answering these two questions.

I confess that I am not a mathematician but a small time investor and trader. My objective is to find investments that preserve my capital and provide a net, positive, real rate of return. Given an opportunity I will of course, pick the higher, risk adjusted, rate of return over the lower. Who wouldn’t? With stocks having fallen some 50% over the past year the gold bugs are out in force. Having been inundated with the buy gold, buy gold, buy gold mantra in the news media, blogs and commentary I have decided to examine gold more closely. Being at best agnostic about gold I wanted to find out if I am wrong and the gold bugs are right or if my negative intuitive response was more appropriate.

The data

I have obtained the annual DJIA values from 1899 through 2008. I have also obtained spot gold prices over the same time period. Since I am examining both vehicles as long term investments rather than as short term trading vehicles I contend that annual prices are sufficient for my examination. To buttress that contention I note that it is exceedingly rare for any gold bug to ever recommend selling gold. And, clearly the most profitable investor of our time, Warren Buffett is a self-described buy and hold investor. Thus I believe annual data is sufficient for a long term investor.

Within the time period available, 1899 through 2008, some anomalies exist. The biggest is that up until 1933 the price of gold was fixed at $20.67. It is not a fair comparison when one investment vehicle is fixed in price while the other enjoys a measure of volatility. Most of my comparisons then are relegated within the time frame of 1933 through 2008. Even so it is interesting to note that from the bottom of the Great Depression (1932) through 1941 (the start of WWII) the DJIA more than doubled while the price of gold languished.

The importance of time

In a previous existence during the Neanderthal period of personal computer technology I spent way too much time examining various rules based trading strategies. Looking back at those efforts it slowly became apparent that the time period of the data played a much greater role in the outcome of those strategies than was initially evident. Now, at a somewhat riper age one of my first questions regarding investment returns and data is, “over what period of time?” Even more important is the second question, “why that time period?”

As an example, the annual price of gold was in a long term downtrend from 1980 through 2000. The spot price declined by over half from a high of $641 in 1980 to a low of $272 in 2000. Over this same time period the DJIA increased by 1000% from 964 in 1980 to 10787 in 2000. Any comparison of gold versus DJIA over this twenty year period is overwhelmingly in favor of the DJIA.

Let’s take another time period. From 1965 through 1981 the DJIA languished from a high of 969 in 1965 down to 875 in 1981 before embarking on a twenty year bull market. Gold also languished from 1965 to 1971 but starting in 1971 gold rallied from 35 to over 430, a 1200% gain. This time the results are overwhelmingly in favor of gold. But does this tell us, as long term investors, which is the better investment?

It still depends

Table 1 below depicts the simple percentage change, or rate of return on a long term investment in the DJIA and gold. The returns are based upon the change in value over a selected period of time. The change in the DJIA value from 1899 through 2008 is 13252% while the change in spot gold over the same period is only 4383%. Since spot gold was fixed from 1899 through 1932 I next looked at the period 1933 through 2008. During that time the DJIA change in value was 8795% while spot gold only gained 2767%. The next data line looked at the post WWII period to the present (1946-2008). The results were similar if not so dramatic.

Table 1 Dow Jones Industrial Average vs. Historical Spot Gold
Percent change in value over indicated time period
DJIA	13252%	1899-2008	4383%	Gold
DJIA	8795%	1933-2008	2767%	Gold
DJIA	4853%	1946-2008	2323%	Gold
DJIA	3628%	1950-2008	2202%	Gold
DJIA	1325%	1960-2008	2439%	Gold
DJIA	1481%	1970-2007	2116%	Gold
DJIA	946%	1970-2008	2365%	Gold
DJIA	810%	1980-2008	45%	Gold
DJIA	233%	1990-2008	119%	Gold
DJIA	-19%	2000-2008	241%	Gold
DJIA	23%	2000-2007	206%	Gold

The remainder of Table 1 depicts the start of a series of time periods to the present, with two exceptions. Given the dramatic selloff in the DJIA and the dramatic rise in spot gold over 2008 I also took a quick look at some results as if the data ended in 2007. These are the periods from 1970 through 2007 and the current decade, 2000-2007. Excluding 2008 data does not alter the direction of the overall results just the magnitude. These are simple calculations, value at start of period (technically end of prior year) versus value at end of period expressed as a percentage of starting value.

What this table depicts is that neither the DJIA nor gold is “THE” single best investment over all time periods and economic conditions. It clearly shows that the time period, which is to say the economic circumstances of a time period, is the determining factor as to which is the better investment.

Value of $1000

I next looked at the data in a slightly different manner, value of $1000 over a selected time period. By only examining data points at the start and end of a time period, the ebb and flow of an investment is masked. While the volatility of an investment is important for long term investors, my objective was to examine the value of $1000 during the selected time period in hopes that would provide additional useful information towards determining which asset is the better investment. Table 2 below shows the value of $1000 at the end of a series of selected time periods.

The results shown in Table 2 were calculated by assuming an initial $1000 investment in each asset using the prior yearend value. That is, for the time period of 1933-2008 the yearend value of 1932 is used to initiate the investment. For the period 1970-2008 the yearned value of 1969 was used as the basis. The investment value was then adjusted up or down depending on the percentage change in each of the asset values as of yearend. The percent change was simply calculated as (last value – first value)/first value expressed as a percent. Table 2 shows the end results of this ebb and flow over various time periods.

Table 2 Dow Jones Industrial Average vs. Historical Spot Gold
Growth of $1000 over indicated time period
DJIA	$145,642	1933-2008	$44,834	Gold
DJIA	$10,966	1970-2008	$26,179	Gold
DJIA	$10,464	1980-2008	$1,601	Gold
DJIA	$3,188	1990-2008	$2,138	Gold
DJIA	$763	2000-2008	$3,223	Gold

Table 2 vividly shows the impact of the different time periods. From 1970 to 2008 gold handily outperforms the DJIA yet starting ten years later, 1980 to 2008 reverses that outcome by a dramatic margin. What happened to change the outcome so dramatically? The obvious answer is that during the mid 1970’s through the early 1980’s the economy was in a serious slump while inflation was raging to historical levels. Stocks were in the cellar while gold was going through the roof. But by the early 1980’s that circumstance had turned. The economy recovered, inflation was abating and gold was declining.

A similar circumstance appears today. Although inflation has yet to rage the economy is in a serious slump (clearly a recession, perhaps a depression) and the price of gold has once again risen to historical levels. Gold bugs are ubiquitous and the economic panic and fear is feeding the frenzy. But does that make gold a better long term investment than equities?

Charts

Chart 1 (shown below) depicts the annual change in value of a $1000 investment in both the DJIA and spot gold from 1933 through 2008. As the chart depicts, the DJIA appears to exceed gold as an investment in all periods except during extreme financial stress. This is evidenced by the value of the gold investment reaching and exceeding that of the DJIA beginning in the mid 1970’s and persisting until the early 1980’s. This period was the worst post WWII recession until the present time. A similar pattern exists during the period from 2000 through 2008 as shown in Chart 2 (shown below). The DJIA shows great volatility with the end result being a severe downturn through the present time.

The economic circumstance that is missing however may be the proverbial 800 lb. bear in the room. So far, inflation is not raging and there are serious people who believe deflation is the more likely event. Is it possible that the gold bugs have acted quite rationally – but too early – to defend against the government’s monetary and fiscal response to the economic turmoil?

Chart 1

DJIA vs Gold Value of $1000 1933-2008

Chart 2

DJIA vs Gold Value of $1000 2000-2008

While gold bugs may have acted early, their combined response has until recently been self fulfilling. Gold has risen from its 1980’s doldrums (after having reached a nadir in 2000) to record highs as of late. What isn’t clear is whether this is a trend that will continue. Note that gold at $2000 has been bandied about much like oil at $200 a barrel was bandied about in mid 2008. Still, there is no denying that gold has seriously outperformed the DJIA over recent years and most especially this last year. But reasonable people can point to the triple economic shocks of (a) the 2000 tech stock bust; (b) the 9-11 attacks in 2001; and (c) the housing/equity bust of 2007-2008 as the reason for the sub-par DJIA. Clearly there have been rational reasons to put more trust in gold over the past eight years. But does that make it the better investment for long term investors?

Chart 3

DJIA vs Gold Percent Change in Value 1933-2008

Percentages

Chart 3 above shows the percentage change in value, as of year end, for gold and the DJIA over the period 1933-2008. These percents are simple calculations of year end price minus prior year end price divided by the prior year end price expressed as a percentage. This chart avoids the starting point distortions evident in the Change in Value of $1000 charts. It also clearly shows the two periods when gold substantially outperformed the DJIA. Gold substantially outperformed the DJIA during the limited period of 1972-1974 and again during 1978-1981. There are other years when gold outperforms the DJIA but none as substantial or long lasting.

My Answer

I’m at best agnostic about gold. I wanted to find out if gold was in fact a better long term investment than equities as typified by the DJIA. I believe that the data has given me an answer: it depends. Whether gold or the DJIA is a better investment depends on the economic circumstances. More specifically gold appears to depend on having a substantial rate of inflation and expectations of future inflation in order to outperform the DJIA. If those expectations are absent then the DJIA outperforms.

After gold hit its record high price in 1980 it slumped for some twenty years while the DJIA had a twenty year bull market. What happened is that inflation expectations were crushed as the government took steps to break the inflation cycle. The key factor in that case is the government correcting the economic issues of recession and stagflation thereby setting the stage for an economic recovery.

When the DJIA gets run over by its own malfeasance or by exogenous factors it too tends to slump for extended periods, circa 1965-1981, 2000-2002 and also 2008-2009. But again, when investors determine that corrective actions are underway that slump (hopefully) ends. Thus rational investors must make a determination as to whether the corrective actions of government are in fact starting to resolve the economic malaise. They must also make a valiant effort to forecast future economic circumstances and from there choose gold or equities.

Inflation or Deflation

Much of the talk today is of the extraordinary government monetary and fiscal response to the economic downturn as an inflationary factor. Even worse, this government response is a global phenomenon unlike mere national recessions of the past. Counter-balancing that are the severe credit restrictions coupled with a substantial downturn in global demand as a deflationary factor. How one interprets the outcome of these factors will determine whether gold or the DJIA is the chosen investment instrument.

One comment I read made a salient point. The unused factory capacity in China, India and the Far East is enormous. Indeed, domestic capacity as well is severely underutilized. Further, inflation is a monetary phenomenon that requires excess capital chasing too few goods. As well, deflation too is a monetary phenomenon but it requires excess goods chasing too little capital. But if the existing supply and potential supply of goods is substantial relative to demand (capital) then perhaps, just perhaps there will be insufficient capital to fully utilize all available supply. Hence, inflation may not be the 800 lb. bear most of us believe it will become. Instead we may actually face a deflationary cycle for the first time in many generations.

This conundrum is explained by the velocity of money. As an aside, capital in this case includes the money supply and the velocity of money or how fast a given dollar gets used. Velocity is currently restrained for a variety of reasons and those reasons may not recede quickly or ever. Baby boomers tend to sway the economy out of proportion to their numbers. If boomers (like me) have permanently changed their consumption habits then it is unlikely that monetary velocity will quickly resume at prior levels. Or, at the least it will not resume anytime soon.

Bottom Line

If your estimation is that future inflation is the most likely prospect then buy gold (IAU, GLD). If your estimation is for deflation then bonds (BND, HYG, LQD) are the better investment. If neither prospect seems most likely then you should select equities (DIA, SPY, QQQQ) to outperform both investments. Pick your poison.

Comments

[Moon Kil Woong:]

I prefer this type of article over ones that are trying to ram a buy or sell point down people's throat with selective information. In reality, none of these types of investments are the best choice in all situations, as they should be.

In the end, to maximize profit and minimize risk we have to be active investors. Not passive lets give it to some random firm or dump it into some random type of investment vehicle and see what happens.

The capitalist theory is that people activly managing capital resources like money will allocate the money to maximize profit and minimize risk to the benefit of all. If no one is actively looking to allocate resouces to the creative and innovative but just putting it into the S&P 500 or growth or income funds then how efficient does the efficient capital theory work? You start to get people like Citibank, AIG, Enron,and the Madoffs. I think the answer is quite clear. Things get very inefficient very fast.

As Prudent Investor points out, if the government prints papper like a mad hatter then people will stop buying treasuries and/or demand higher interest and rather than stimulating they merely will be causing inflation.

If corporations become the pinnacle of misappropriation of money and risk then investors will sell them and will make it hard or impossible to go to the bond market to get cash without paying a huge premium.

If commodities (gold is one despite peoples prognostations otherwise) don't scale back production in the face of faling demand then they will be looking at very low prices sooner or later even if they convince people to pilfer away as much as possible in vaults. That only takes some percentage of production off the market.

If all of these things look grim you can always invest in yourself by inproving your education, or being selective in what equities you invest in, or start your own business. I am not a broker so I have no problem in saying that your investment options are only limited to ones that make a trasaction fee for the financial industry.

If you are not independently wealthy it's also helpful to remember your job is probably your most important asset. Spending extra time and money to improve it may be the best investment advice you'll ever get.

Mar 17 09:14 AM

[kelm:]

I saw a comment a day or two ago that described gold as an irrationality index. That is, when investors are feeling irrational panics they buy gold. As such then it is an insurance policy if you intend to hold it long term or it is an asset class that can be traded very profitably (long or short) during periods of turbulence. The gold market is driven by physical buying though and that physical buying, despite all of the gold coins world wide that mints are churning out, is still dominated by India, Turkey, the Middle East and some others and it is largely for jewelry demand. That has dried up in recent weeks which is what is leading to the current decline in price - which I think has farther to go.

So the simple answer is that gold, like equities, bonds, and other commodities, has it's time and place. The cult of the equity has attempted to convince investors that stocks are the only place to be all the time. This is completely false and we recently have seen that the 30 year bond has beaten stocks since 1969.

Investors should look a all markets With the ETFs available today there is virtually nothing you cannot trade or invest in on the long or short side.

Mar 17 09:19 AM

[Hal.P.:]

I agree with many of the comments. A fair number of folk see gold as a long term store of their wealth. It's not a lump of metal that returns dividends like the stocks of some companies. It is an item that holds it's monetary value over time and performs it's task when needed.

Mar 17 09:22 AM

[tiananman:]

Gold is not an investment. It's a store of value. You conflate the two throughout your article.

You also ignore the fact that ownership of gold was illegal for 41 years. Doesn't that kind of skew the data?

The article also presupposes an either/or situation. No one would recommend putting all of your money in gold, nor all of it in the stock market.

I really don't understand all of the logical stumbling blocks people try to put between themselves and the ownership of gold. For instance: no one has a problem with buying gas to put in their car. Gas, like gold, corn, whiskey, etc. has a function, and trading in dollars for any one of them doesn't make you crazy. Gold's function is a portable store of wealth. It has intrinsic value as a store of wealth. Paper does not. Gas has an intrinsic value as fuel that you put in your car. Trading a temporary, extrinsic store of wealth (paper dollars) for something real is not the act of a madman. Everyone does the very same thing every day!

Mar 17 09:27 AM

[originalfred66:]

The key is to be in the right asset class at the right time in the long term cycle. The long term chart of the Dow/Gold ratio clearly shows this.

home.earthlink.net/~intelligentbear/com-...

From the site:

The Dow/Gold Ratio chart shows the ratio of the price of the Dow to the price of gold. Another way to look at it is the number of ounces of gold it takes to buy one share of the Dow. For example, with the Dow at 10,000 and gold at 500, it requires 20 ounces of gold to buy one share of the Dow, so the ratio is 20. The reason for using gold is that gold is the most unbiased form of money in existence. Fake government paper money comes and goes, but gold has been money for thousands of years. It is the ultimate store of wealth.

The chart shows the cyclical nature of the battle between paper assets and hard assets. Paper assets excel when everyone is fixated on growth. When the growth phase ends, and preservation of wealth becomes the paramount concern, gold tends to excel. When paper burns, gold shines.

Mar 17 10:07 AM

[originalfred66:]

Links do not work very well on this site. Try this and remove the space.
http:// home.earthlink.net/~in...

Mar 17 10:13 AM

[originalfred66:]

One more try with 2 spaces.
http:// home.earthlink.net/ ~intelligentbear/com-d...

Mar 17 10:15 AM

[originalfred66:]

Almost got it. Let's try 3 spaces.
http:// home.earthlink.net/ ~intelligentbear/ com-dow-au.htm

Mar 17 10:15 AM

[Glen L.:]

tiananman says it best, I think. The point about gold being illegal to own, except by governments, is salient. In the last couple of weeks I've had an email argument with this guy who thinks I'm an idiot for believing gold is worth more than $42/oz, because that's what the central banks and IMF say its value is. That price is obviously a vestige from the fixed price days prior to the re-legalization of private ownership; after that, the law of supply and demand and the fear factor took over, and I think the current trading range of about $850-1000 is very rational, at this point. When (not if) serious inflation rears its ugly head, the price will soar, since gold is denominated in dollars.

Mar 17 10:17 AM

[@TexasER:]

Good research. Even though I'm a spreadsheet guy too, the result of that analysis should invariably be "it depends."

When it says "always" then watch out.

Mar 17 11:04 AM

[Vuke:]

A good article. It tries to balance a fixed reality, gold, against highly variable and volatile ones such as the DOW (always changing) and currency (always increasing).

Gold is Central Banker's currency of last resort, which is why they stockpile it. In uncertain times there is a shift to ownership, in predictable times more is gained by investment in business.

Currently many people believe it wise to hold, which is raising its price, and CB's seem to agree. During what may be a long period of adjustment it will serve a useful role.

Mar 17 11:52 AM

[yellowhoard:]

It seems to me that when the dollar is pegged to gold, the Dow outperforms the metal. And, the inverse is true when the peg is taken away.

Mar 17 12:04 PM

[dieuwer:]

It would be interesting to compute the returns for a hypothetical portfolio comprising 50% gold and 50% DJIA and have it rebalanced every 5 years or so.

Mar 17 02:29 PM

[Gedankonomist:]

"I’m not a gold bug. I believe gold’s use as an investment and store of value is a historical artifact not well suited to the modern era."

Which correlates well with gold going from $300 to $900 over the span of 6 years, while stocks have gone into the hole. What planet did you say you lived on?

Mar 17 02:57 PM

[5142152-337:]

Whew, my eyes hurt after reading this epic piece of work. But, it does give one pause, just long enough to wonder where to go to buy more gold (and silver).

Mar 17 06:31 PM

[Bill Zielinski:]

Awesome piece of research. It's very interesting to see that gold has outperformed the Dow since 1960. So much for the buy and hold theory for stocks.

Mar 17 09:35 PM

[Old Trader:]

A good article, addressing a contentious issue. Fwiw, I've got a bit bit of exposure to gold, via PM miners, and overlaying a chart of GLD on a chart of SPY, shows a fair bit of negative correlation, at least over the last couple of years, so there IS value there as a hedge, as others here have commented.

Mar 18 12:07 AM

[Gold Barron:]

Let's see what the 2009 first quarter earnings results are!! The stock market is going lower and gold is going higher. Plain and simple.

Mar 18 02:48 AM

[Jeffrey A. ...:]

DJIA vs. Gold Gold as a store of value March 19, 2009

I appreciate all the comments on my article. Those who think me an “idiot” will not be surprised to learn that my wife agrees with them at least once a week. In an effort to diminish that view I have done a bit more research to compare gold with the CPI (consumer price index) as published by the Bureau of Labor Statistics. The CPI is available from 1913 to the present. I selected, again, the annual values to compare with the annual spot price of gold. Several comments suggested gold is an insurance policy against inflation I presume. Others suggested gold is a “store of value” (SOV) not an investment, again I presume against the loss of value due to inflation. At least one excoriated me for ignoring the fact that ownership of gold was prohibited until 1974.

The comment about gold ownership being prohibited until 1974 ignored the main thrust of the article. Gold completely failed as an investment over the twenty year period from 1980 through 2000. Yet gold was freely traded during this time. I examined the longest possible historical record to obtain as much information as possible about the relative value of gold versus the DJIA. Yes, gold was prohibited until 1974. But ownership of stocks was relegated to a small minority of the population as well. Neither fact changes the conclusion of the article that whether gold outperforms the DJIA depends on the current economic circumstances. Neither is “best” at all times.

As insurance against inflation I believe gold also fails since insurance is designed to replace value dollar for dollar. If 10% of a portfolio is in gold then a doubling of the value of gold is required to increase the portfolio by 10%. Stated differently, to protect against a 10% inflation rate requires that gold (at 10% of the portfolio) double in price. Gold certainly can double in a year (or less) but it has never done so over any extended period of time and never done so during periods of low to moderate inflation. Gold only jumps in value during periods of extreme financial stress. Of course, today we are in fact experiencing extreme financial stress so gold is doing well. For now.

As a store of value (SOV) gold, or any asset for that matter, must also perform well as an investment. I am clearly not the brightest bulb in the chandelier but I cannot understand how a poorly performing investment can succeed as a store of value. But set that argument aside. Given a historical record of the CPI how does gold stack up as a store of value? The BLS statistics set 1982-1984 as 100 and then adjust the CPI up or down accordingly. Thus if inflation at some future time is double what it was in 1982-1984 the CPI goes to 200. If it were half the CPI drops to 50.

Since the 1983 CPI is set at 99.6 I arbitrarily used that as my base level for inflation. Also, since gold had been trading freely at that time I set the yearend spot price of gold, 415.00 as my base level for the price of gold. Using the base level of gold I then adjusted the price using the annual CPI figures for each year. By coincidence the CPI adjusted price of gold in 1974 was 203.78 versus the actual spot price of 195.20 which is extremely close.

There were several interesting results from this exercise. First, the CPI adjusted price of gold was well above the government set levels from 1913 through 1973, sometimes by 2 or 3 times. This suggests the government was arbitrarily devaluing the dollar, in gold terms during this period. No big surprise there. What was a surprise is that from 1974 through 1978 spot gold was still below the CPI adjusted level. However, even more stunning is that the only times spot gold exceeded the CPI adjusted level was from 1979-1983 plus 1987 and 2008. If we only look at the period from 1974 through 2008, when gold was freely traded its SOV function was only reliable for a single 5 year period plus two additional separate years of extreme financial stress. Obviously 2009 and beyond may add to gold’s SOV utility.

My conclusion is that gold as a store of value, as a hedge against inflation and as an investment is only valuable during periods of extreme financial stress. We are in such a period at the present. Gold is doing well, at the present. Stay alert for improvements in the underlying economic circumstances and protect yourself. The gold versus CPI table is available at redst8r.wordpress.com

Mar 19 01:32 PM

[oldbluejeans:]

Seems to me that comparing gold to the DOW is the wrong comparison. It should be gold vs $. Neither currencies nor commodities ever go to zero. But currencies can get so close to zero that they in effect become worthless, (Zimbabwe today, or the Weimar Republic in the 20th century). Gold though, has never gone near zero, not even in the case of government debasement of gold coins with copper. They still had at least some value, depending on the amount of gold in them.

Mar 21 06:31 PM