For the most part, I do not spend a lot of time thinking about gold as a potential investment. There are a couple of reasons for this. First of all, it is a non-productive asset. An ounce of gold today will be an ounce of gold in 2023. Nothing happens to the asset (your only hope is that someone out there is willing to pay more for that ounce in 2023 than today). Unless an asset is undervalued at the time of purchase, it is incredibly difficult to generate inflation-beating returns if it does not experience growth (and the static nature of gold prevents this).
And secondly, I have read the data from Ibottson Associates that points out the performance of all asset classes since 1926. If we strip out inflation and talk in terms of purchasing power, large-cap stocks have returned 6.7% since 1926, corporate bonds have returned 2.9%, and gold has returned 2.1%. And, of course, if you do not adjust for 3.5% inflation, you will see that large-cap stocks return 10.2% since 1926, corporate bonds return 6.4%, and gold returns 5.6%. The disparity between the performance of large-cap stocks and gold has been so great over the 86 years that I have felt comfortable believing I could draft a strategy without it, especially taking into account the fact gold, like all non-productive assets, is unable to grow into anything.
A common argument in favor of holding gold is that "the dollar is being trashed" or "cash loses its purchasing power over time due to inflation." Both of these statements contain likely truths, but they set up a false alternative. As investors, we do not have to choose between gold and the United States dollar. Rather, we get to choose whether we want to allocate our investable surplus towards gold or productive businesses that are denominated in the United States dollar.
A lot of times, gold is touted as an inflation hedge. That is true when you compare gold to cash alone. But it is a terrible long-term inflation hedge when compared to productive businesses that come with natural inflation hedges. Give me a $25,000 basket of Exxon (XOM), Chevron (CVX), Conoco (COP), and Royal Dutch Shell (RDS.B) and I would love to play my odds against the performance of gold over a 15 to 20-year time frame. Those four are high-quality businesses that deal in energy commodities (which naturally hedge against inflation) and generate substantial cash flow that can be used to fuel growth, pay out dividends to shareholders, or buy back shares.
The phrase "cash-generating" is one of those automatic phrases used to describe stocks that pay dividends that cause the term, unfortunately, to lose some of its meaning. But the ability of companies (such as those listed above) to pay dividends during periods of decline is one important advantage that a dividend-paying company has over a hard asset such as gold.
Some of us are aware that gold has fallen from $1,800 to $1,300 over the past year. But here is a reason why I feel no desire to invest in gold: there is no way to benefit from this decline in price. Sure, if I already owned gold, I could buy some more. But there isn't anything that the asset itself can do during periods of decline to reward investors while the price of gold is down. You're just stuck until the price goes up.
This is a sharp contrast to an excellent company that pays a dividend. Right now, General Electric (GE) pays an annual $0.76 dividend. If the price of the stock fell to $10 per share, this would benefit a long-term shareholder immensely because he could plow those dividends back into the company. If someone owned 1,000 shares of GE and the price muddled at $10 for a year, he would receive 76 fresh General Electric shares just for clicking the "reinvest dividends" box on his brokerage account screen.
When prices are down, dividend investors get to turbo-charge their household income by purchasing additional shares at lower prices. From an income growth perspective, lower stock prices are a complete blessing. When the price of gold falls, all you can do is rub your shiny metal and hope the price goes up. There's no benefit to the price decline.
When I consider a potential investment, one of the things I consider is this: What does the strategy look like during bad times (in particular, severe price declines)? With gold, I do not like the answer. There is nothing gold itself can do when the price falls. You just have to wait for it to go up. You do not receive any benefit for weathering a 30% decline. But if you own a dividend stock, the declines are your friend (provided the business itself does not deteriorate). By choosing to reinvest the dividends, the price declines turn out to be the best thing that could happen to you.
Seriously, if you have held any stock for 5+ years, pull out an old brokerage statement of your individual stock holdings. What was more fun: reinvesting dividends into Colgate-Palmolive (CL) in the $50s during 2008 and 2009, or reinvesting at $110+ these days? In 2008 and 2009, you got to buy twice as many shares with your dividends. That means twice as much income. Once you've held a high-quality dividend asset for 10+ years, you will be able to look back on your brokerage statements and truly see that it is the periods of severe declines that made you the most money. The fact that the business throws off income for you to reinvest is a tremendous blessing. When gold falls, you receive none of these benefits.
Non-productive assets do not advance the civilization. They just sit there. An ounce of gold in 1920 is an ounce of gold in 2013 and it will just be an ounce of gold in 2123. It does not change. It does not produce anything. The unfortunate side effect of this is that, during periods of price declines, you receive no benefit for enduring the decline. The asset just sits there. I like benefiting from stock price declines. That's why I want assets that throw off cash to reinvest in the business when prices are down. It's a great way to take charge of what Mr. Market throws your way. Unfortunately, as gold investors are learning today, you are largely helpless when the price of the metal nosedives. If you find assets that pay dividends, you will not have to cope with this disadvantage when prices decline.