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The value of gold (NYSEARCA:GLD) is in the eye of the beholder. It does not generate income or provide much utility to investors, gold-coin baths notwithstanding. Instead, investors buy gold because 1.) They think it will be a reliable store of value, or 2.) Its price in dollars will go up over time. The big concerns usually cited by gold investors are the debasement of the currency and systemic collapse.

The first is a real issue that all investors must consider when constructing their portfolios. The second is not. American capitalism has survived a revolution, a foreign invasion, a civil war, multiple depressions, world wars, stagflation, financial crises, and, most dangerously, CNBC. Economic performance going forward may be subpar, but prophesying the end of the world is a non-starter when it comes to investing. If the end is nigh, you should be consuming.

Gold vs. Real Dollars

Given that the valid rationale for investing in gold is maintaining purchasing power, how good has gold done versus inflation since Nixon ended direct convertibility in 1971? To answer this question, I tracked the nominal price of gold since 1971 and a hypothetical security I call "Real Dollars". Like gold, Real Dollars would generate no yield, but instead increase in nominal price at the exact rate of inflation according to the Consumer Price Index. I use Real Dollars instead of treasury inflation-indexed securities, because the latter first became available in the 1990s, and gold investors explicitly choose a zero-yield investment in the hope of preserving value. Here are the results:

(click to enlarge)

There's a lot for goldbugs to cheer about in this graph. Gold has handily outperformed Real Dollars since 1971. But two other aspects of this figure should trouble gold investors: 1.) The prices of gold and Real Dollars can become inversely correlated for decades at a time 2.) The relative price gap between gold and Real Dollars is very volatile and high gold price multiples relative to Real Dollars indicate poor performance going forward. These two facts mean that gold is often a poor store of value, especially when its price has risen much faster than inflation.

In recent years, fears about the Fed's loose monetary policy and additional financial crises have pushed up the price of gold at a much faster rate than inflation. In 1980, the price of gold was 7.5 times the price of a Real Dollar, reflecting high current and future expected levels of inflation. By 2000, that gap had shrunk to 1.6 times, reflecting robust economic growth, a booming stock market and low inflation. At the end of 2012, gold was nearly 7 times the price of a Real Dollar, a nosebleed valuation that has never been sustainable.

If the price spike that peaked in 1980 is any guide, the current gold bubble will slowly deflate over the coming decades, as investors realize that they want to own assets with yield rather than an asset with no yield that falls in price. At 1.6 times the current price of Real Dollars, gold would sell for about $370 per ounce. I'm not sure if it will ever get to that level, but it is very clear that relative to Real Dollars, gold is quite pricey. Furthermore, the current bubble is occurring during lower levels of inflation than in 1980, which means that the current price is primarily a reflection of high future expected levels of inflation. While inflation will likely pick up a bit in the future, gold could still experience a significant fall if inflation increases are lower than those embedded in its price.

Sell Gold

In conclusion, I believe that gold is a poor investment right now. The price of gold has jumped fourfold in the last decade, while a dollar in 2000 is worth only 33% more than a dollar at the end of 2012. Those gains beyond inflation protection are primarily speculative, in my opinion, and investors should cash their profits while they still can. Purists may take issue with the Consumer Price Index and argue that inflation numbers are manipulated. Even if this were true, such faulty statistics fooled enough people from 1981 to 2001 to push down the nominal price by more than 50%. Gold investors, get out while you can.

Source: Gold Is Worth $370 An Ounce