Gold as an Inflation Hedge 57 comments
an article to
-
Font Size:
-
Print
- TweetThis
Investing in Gold is the latest rage. The Gold craze has only been fanned by recent moves into Gold by the hedge-fund legends David Einhorn, John Paulson and others.
Gold as a Diversifying Asset Class.
Historically, Gold has had zero correlation to the stock market. No one has shown a ironclad inverse correlation between the price of gold and the price of stock indexes. That is Gold does not always rise when stocks fall. Even if such a correlation could be "proved" through data-mining, it wouldn't mean much, because correlations change over time. At one time bonds used to be inversely correlated to stocks and when stocks went up, bonds fell. That relationship changed over time.
Question: "Is Gold a Diversifying Asset Class?" The answer is: Yes, but there are other classes that diversify just as well.
Question: "Is Gold about to rally?" We could very well be on the verge of a global Gold rally. Gold could go to $500 or it could go to $2000. I have no crystal ball. No one does.
Is Gold a Good Inflation Hedge?
From 1801 to 2003, one dollar's ($1) worth of Gold has appreciated and is now worth $1.39 in inflation adjusted terms. Cash has done alot worse: $1 in Cash is now worth $0.07 in inflation-adjusted terms. Because Gold has beaten cash mightily doesn't make Gold a superb investment. Stocks, Bonds, Real Estate and even interest-paying Bills have clearly beaten Gold and cash over the same time period.
One could say "yes, but those were during times of low inflation, when the currency was backed by Gold. What about these modern times when the Dollar is a fiat currency, backed by nothing?"
In 1934, the U.S. went off the gold standard to limit private citizens' access to gold. It took decades for the Dollar to be fully delinked from Gold. 1934 is a great starting point because it marks a period of successive devaluations of the US Dollar vis-a-vis the price of Gold.
Taking 1934 as the starting point, Stocks, Bonds, and Real Estate have clearly beaten Gold over the period. Treasury Bills are a wash.
Question: "Is Gold a Good Inflation Hedge?" The answer is: yes, but their are FAR BETTER inflation hedges, that pay you interest. Gold does not pay interest, in fact it costs money to insure and store. The same goes true for other Precious Metals (PMEs) – these are less preferred investments because they are stores of value, not income-generating investments.
Earlier, I mentioned David Einhorn and John Paulson, two very successful Hedge Fund managers who are currently bullish on Gold. Here is what the most successful investor of all time, Warren Buffet, has said about Gold:
"It gets dug out of the ground in Africa or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it."
To be fair, over the past decade, Gold has outperformed the stock of the vaunted Berkshire Hathaway, Warren's holding company, as fellow Seeking Alpha author Mark O'Byrne writes in his article: seekingalpha.com/artic...; Over the longer term, Warren Buffet has mightily beaten Gold.
Gold as a Store of Value
During the Roman Empire a consumer could purchase a complete suit of high end clothes for one ounce of gold. The suit of clothes consisted of a bespoke (tailor made) toga, high end sandals and accessories. At the height of the Great Depression a consumer could purchase a complete suit of clothes for one ounce of clothes ( bespoke suit, shoes & accessories ). Today, a consumer can still purchase a new tailor made suit, a belt and pair of shoes for that same one ounce of gold. Gold has been excellent store of value for the very long term (Measured over millenia).
Gold does keep up with inflation. Because Gold is better than cash and bills doesn't mean you should go out and buy Gold. There are far better alternatives to Gold, like TIPS, which are alot less volatile.
Nothing excites the investing community more than the talk of Gold. I am sure that this post will get hammered by the Gold Bugs. I am not an expert in PMEs, I know enough to know that there are better choices for my own portfolio.
Gold does have it's uses at the right place and the right time: Gold was useful for the Jews during Nazi-occupied Germany. The Jews knew or suspected that their property rights (to Real Estate & Stocks) would not be honored. The German Mark was unstable as well. In times of war or a total collapse in governmental institutions, Gold has served it's purpose as a portable store of value. Gold is a choice for those who feel that war, country wide financial collapse and/or armageddon is just around the corner. When armageddon comes, you will have more things to worry about than how much Gold you have.
I am curious as to why investors buy slips of paper that represent stores of gold (e.g. the GLD ETF). If the financial system collapses, these slips of paper would not be redeemable into the actual metal. These investors would be better served holding the physical metal.
For the conservative, prudent investor who is optimistic about the future, and wants to grow his capital, Gold and other PMEs are a lousy place to put your money.
Inflation Fighters, Superior To Gold/PMEs:
Because Gold has not been shown to significantly increase in value in inflation-adjusted terms in neither the past two millenia, past two centuries, or past fifty years, Gold is a store of value, not an income-producing investment. To add to Gold's poor choice as an asset class: it is very volatile. Over the past 40 years, Gold's volatility has exceeded those of stocks. I prefer to be an investor, not a speculator and that's why Gold (or other PMEs like Silver) are not in my portfolio.
DISCLOSURE: Long VNQ, U.S. Equities, Non-U.S. Equities, Emerging Markets Equities, US TIPS and WIP. Except for the gold chain around his neck, Author is neither long or short Gold or other PMEs. You should perform your own due diligence and consult with an investment advisor before investing.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
The Hunt brothers took physical delivery of their silver. They hired sharpshooters to protect them as they transported their silver to their warehouse.....and........ Hunt brothers were buying all the silver futures contracts they could, using leverage. Financial industry insiders were naked short selling all the silver futures contracts they could. There was no way all this silver could be physically delivered. There was a real risk that there would be a default on the silver futures contract.
It is evident from this, that they were taking delievery on ALL the contracts they were buying. My point exactly. Yes, of course they used leverage entering the positions but they were paying CASH for all those contracts and demanding their actual phusical silver! It was NOT the leverage that did them in!!!! That was all I was trying to get across!
On Jun 06 05:49 PM bkdc wrote:
> On Jun 06 10:47 AM Market Sniper wrote:
TIPs: If interest rates soar like I expect them to, isn't it possible all my CPI linked capital gains could get wiped out? What if the value of the dollar declines by 50%?? Relying on the govt to accurately report inflation numbers and protect my investment seems like an awful big leap faith to me. If the bond market tanks, TIPs are going to get crushed right along with plain vanilla treasuries.
REITs: The logic goes that rents increase in inflationary times, but does this hold true in a collapse led by a real estate meltdown?! Rents are going down, not up, and will likely continue to head lower until supply and demand come back into balance. Unfortunately for the REIT investor, this could be long after inflation becomes a real problem.
Personally, I see all the inflationary capital flows eventually heading into emerging markets and commodities. I view dividend-paying foreign equities, especially in the natural resources space, as the most desirable place to be. Maybe I've been listening to Peter Schiff too long, but I still think he's got it right. Just a little early.
Warren Buffett's FATHER was a hard money man who understood the value of gold and silver.
But for some reason, that has been the blind spot of Warren Buffett himself. He dumped his silver holdings, mid-decade, just as it was about to take off, and never did buy gold.
On Jun 06 10:37 PM Smarty_Pants wrote:
> Good article. It's apparent you are rather dispassionate on the
> topic, which is the only way rational people can winnow the wheat
> from the chaff.
>
Thanks for the praise, Smarty Pants. I appreciate your comments, you make some valid points and I will address them one by one.
> There are a few points regarding the topic of holding gold that could
> use a bit more in the way of fleshing out.
>
>
> 1) "From 1801 to 2003, one dollar's ($1) worth of Gold has appreciated
> and is now worth $1.39 in (2003) in inflation adjusted terms."<br/>
>
> And since 2003 the price of gold has increased from an average price
> of $380 to $950 making its inflation adjusted value closer to $3.50
> today. Let's not ignore the significant rally of the past several
> years.
>
Accepted. You are indeed correct. My error was that I posted data only up to 2003. (I felt that the 1803 to 2003 data was the best long term data that I had.) Despite the fact that Gold has tripled since 2003, Stocks and Bonds and have undeniably trounced Gold in the two periods 1803-2009 and 1934-2009.
>
> 2) "Hypothetical Example: If you hold nothing but Foreign TIPS, and
> they devalue the dollar to 1/10th it's value, you could care less,
> because you hold a diversified basket of foreign currencies ... If
> at the same time, we experienced world-wide global inflation, you
> would still care less because the foreign holdings are inflation
> protected."
>
> You might also point out that this 'trade' also brings with it a
> large counter-party(s) risk. Are you holding all those foreign assets
> in your own hands or are you depending on the solvency of your brokerage/dealer?
Smarty Pants -
Counter-Party risk is primarily in ETNs. WIP is not an ETN - it is an ETF. The solvency of the Broker/Dealer has no bearing in the case of ETFs. The solvency of the ETF sponsor also has no bearing. The shares of the ETF are held in my name at the repository.
> How long might it take to convert these instruments to something
> you can spend, if you can convert them at all? Confederate States
> bonds are worth far more today as collectibles than they were ever
> worth after being issued.
Smarty Pants - I love your comment about Confederate States Bonds. My Dad is a Southerner and he used to jokingly tell me "Save your Confederate money, for the South shall rise again!!!"
As for your question " How long might it take to convert these instruments to something you can spend, if you can convert them at all?"
That is the beauty of an ETF. When there is net selling of an ETF, after a certain breakpoint of net selling (10 million or so dollars) - if their are no buyers it drives down the spread. Authorized Participants (like market makers) can then buy the WIP ETFs being sold and then present them to the Fund Sponsor in exchange for the actual components - the actual certificates for the individual Foreign Sovereign Inflation-Protected Bonds. Foreign Sovereign Bonds are for the most part liquid. Granted, you may take a hit on a few bonds (like Italy and Ireland Bonds, ) but they are a fraction of the portfolio.
On Jun 06 10:37 PM Smarty_Pants wrote:
> You can
> easily store 50 oz. of gold in your home without cost. It isn't
> that hard to find places to hide it either. If you can keep a secret
> and accumulate the gold over time, nobody will suspect it is there
Smarty Pants - you have many of the more unsavory folks out there wondering "which particular house does Smarty Pants live in?" <grin> You better keep that a secret.
CAUTION TO OTHERS:
Remember that most homeowners insurance policies only cover up to $200 in bullion. If you do hold physical Gold/Silver/PMEs, you can increase your insurance limits with a rider on your insurance policy.
Having said the above: My article makes clear, I am not an advocate of holding Gold in any form (except the shiny chain around my neck)
>
> TIPs: If interest rates soar like I expect them to, isn't it possible
> all my CPI linked capital gains could get wiped out?
D P - I have no idea what you mean by "CPI linked capital gains"
> What if the value of the dollar declines by 50%??
TIPS don't protect you from devaluation per se. However, when a currency devaluates there is a nearly corresponding rise in inflation (though somewhat delayed). If you hold TIPS and the dollar suddenly drops 50%, you are indeed down 50%. At that point, inflation should rise approximately 100%, because all the global commodities are now twice as expensive in Dollars. Global Commodities: Oil, Food, Clothing, Anything you buy at Wall Mart all goes up 100%. Rent will stay the same until the landlord realize that dollars are more worthless, and start jacking up their rates, upon leases expiring, so eventually two they will go up (Delayed effect)
I do not know the exact proportion of the relationship (correlation) between devaluation and inflation the two are linked, but their is not a one-to-one correspondence. This is because much of what we consume is a local commodity not a Global commodity.
Still, even after having said the above, if you are worried about the US Currency devaluing more than the rest of the world, holding some of your portfolio in Foreign TIPS and Foreign Equities is the thing to do.
On Jun 07 09:45 AM Dollar Pimp wrote:
> Relying on the govt to accurately
> report inflation numbers and protect my investment seems like an
> awful big leap faith to me. If the bond market tanks, TIPs are going
> to get crushed right along with plain vanilla treasuries.
>
Smarty Pants - I am also concerned about the accuracy of the reporting of the US CPI. All the experts agree that the CPI is under reported. None of the experts can agree by how much the US is under reporting inflation, but my feeling is and the consensus seems to be that it is about 1% fudge factor. A little bit of under reporting is OK, alot of under reporting would be a disaster for TIPS holders. I wrote a paragraph or two about this topic HERE IS THE LINK:
seekingalpha.com/artic...
An excellent inflation hedge not mentioned in the article - direct farmland investments. Farmland has a very high positive correlation to inflation like gold, but generates consistent income from rents - so much so that it is often described a "gold with yield". Jim Rogers is a big advocate of farmland investments for two key reason - unimpaired fundamentals in the ag space (think “food, feed, fuel”) and returns that have a high positive correlation to inflation. Rogers is on the board of Agcapita, a farmland fund focusing on Canada.
So there are as many as three counter parties to your transaction under 'normal' circumstances. Authorized Participants, Fund Sponsor, and the Foreign Government issuing the bonds. The latter two would be involved under all cases. While this may not be an issue most days, a sudden market cataclysm might easily make conversion into physical cash an arduous process.
"Foreign Sovereign Bonds are for the most part liquid."
So were Confederate Bonds in 1861, by 1864 not so much. I would consider the cash sitting in a money market fund at my broker to have counter party risk at some level because I am relying on my broker to send it to me should I want it. It is entirely possible that it might never be returned.
If one is going to compare investment at the level of 'cost of storage', 'counter party risk', etc. then it would make sense to consider all the risks of both options when making a comparison. Ask someone who held bonds in GM or WaMu about counter party risk.
As for storage, even if your readers knew where I lived they wouldn't find my physical gold. It's safely out of harm's way. Few know I have it and most of those don't have any idea how much I hold, which is how I prefer things to be.
You do make a good point regarding the ease of use for ETFs however. For someone taking short term positions, they are hard to beat. The overhead and transaction costs are negligible.
"CAUTION TO OTHERS:
Remember that most homeowners insurance policies only cover up to $200 in bullion. If you do hold physical Gold/Silver/PMEs, you can increase your insurance limits with a rider on your insurance policy."
Glad you mentioned that. After having a strange experience with lots of unsolicited calls from insurance companies, just when I happened to have cancelled a policy, I consider some insurances (such as home content) liabilities rather than assets, due to possible "leakage" from their databases.
Better to rely on solid alarm systems or professional (overseas) custodians.
> On the issue of TIPs there is a quote from Marc Faber that is both
> entertaining and insightful: "Never ask the barber if you need a
> haircut. Never ask the realtor if the house you are considering buying
> is a bargain at the price offered. And never ask the government to
> calculate the rate of inflation when it can save millions of dollars
> in cost-of-living adjustments."
>
Farmland - I wrote a piece about the accuracy of US TIPS in one of my artcles: seekingalpha.com/artic...
As well, I posted Bill Gross' article about the same subject in my Instablog: seekingalpha.com/insta...
I agree with Bill Gross: CPI is understated by appx 1% in the USA.
> An excellent inflation hedge not mentioned in the article - direct
> farmland investments. Farmland has a very high positive correlation
> to inflation like gold, but generates consistent income from rents
> - so much so that it is often described a "gold with yield". Jim
> Rogers is a big advocate of farmland investments for two key reason
> - unimpaired fundamentals in the ag space (think “food, feed, fuel”)
> and returns that have a high positive correlation to inflation. Rogers
> is on the board of Agcapita, a farmland fund focusing on Canada.
I agree. I added Real Estate in my skimpy list of inflation-fighters. I am sure someone will come out with a Farmland REIT, if they haven't already done so.
>
> So there are as many as three counter parties to your transaction
> under 'normal' circumstances. Authorized Participants, Fund Sponsor,
> and the Foreign Government issuing the bonds. The latter two would
> be involved under all cases.
>
A Counter-Party Risk involves credit risk. There is no credit risk from the Fund Sponsor as they are merely aggregators / custodians of the share certificates. The only Credit Risk is from the Foreign Govts.
> While this may not be an issue most
> days, a sudden market cataclysm might easily make conversion into
> physical cash an arduous process.
During financial armageddon, true, all bets are off.
> "Foreign Sovereign Bonds are for the most part liquid."
>
> So were Confederate Bonds in 1861, by 1864 not so much. I would
> consider the cash sitting in a money market fund at my broker to
> have counter party risk at some level because I am relying on my
> broker to send it to me should I want it. It is entirely possible
> that it might never be returned.
>
When the MM Funds broke the buck, it was due to the failure of the underlying securities (counter-party risk of the individual holdings in the mutual fund) , not the failure of the fund sponsor. That was because these MMs were backed by non-government paper, and by some pretty shaky corps. no MM Fund with only govt securities ever broke a buck.
AIG, Lehman ETNs presented a huge counter-party risk and that's why I am against ETNs. You could lose your entire investment when Lehman bankrupted.
> If one is going to compare investment at the level of 'cost of storage',
> 'counter party risk', etc. then it would make sense to consider all
> the risks of both options when making a comparison. Ask someone
> who held bonds in GM or WaMu about counter party risk.
>
> As for storage, even if your readers knew where I lived they wouldn't
> find my physical gold. It's safely out of harm's way. Few know
> I have it and most of those don't have any idea how much I hold,
> which is how I prefer things to be.
>
Still, Smarty_Pants. you really should get insurance.
> You do make a good point regarding the ease of use for ETFs however.
> For someone taking short term positions, they are hard to beat.
> The overhead and transaction costs are negligible.
Tern, you really should get insurance.
On Jun 07 11:03 PM TERN wrote:
> The author said:
> "CAUTION TO OTHERS:
> Remember that most homeowners insurance policies only cover up to
> $200 in bullion. If you do hold physical Gold/Silver/PMEs, you can
> increase your insurance limits with a rider on your insurance policy."
>
>
> Glad you mentioned that. After having a strange experience with lots
> of unsolicited calls from insurance companies, just when I happened
> to have cancelled a policy, I consider some insurances (such as home
> content) liabilities rather than assets, due to possible "leakage"
> from their databases.
>
> Better to rely on solid alarm systems or professional (overseas)
> custodians.
Not yet anyway. You may get your buck back, but it might not buy very much if every foreign government on the planet holding dollars decides to sell in short order, for whatever reason.
Then again, until 2008 the US money supply, as measured by the FED balance sheet, had never doubled in a few months either. Conditions underlying the stability and value of the dollar are much changed from even recent history. This is something one needs to take into account when assessing their risk of varying assets.
It's also one reason why gold has become more 'popular' in the past few years. Those who have studied the history of fiat money understand the risk inherent in paper money and assets based on it.
Remember, the green pieces of paper in your wallet are "Notes", not money. Legally they are an IOU from the Federal Reserve, which has been allowed to redeem them in other IOUs since the early 1970s. In fact they are pieces of green paper, worth little or nothing in reality. If worldwide confidence in the dollar ever evaporates, it may not be terribly welcome in free trade. (Think Weir mark or Zimbabwe dollar.) This is a risk everyone is forced to take every day unless you exchange the IOUs for tangible assets like gold, real estate, productive equipment, etc.
Thanks for discussing the finer points Living4Dividends, I'm sure there are many readers out there who benefited by hearing different sides of the coin.
Good fortune with your investing choices. May we all manage to prosper without undue hardship.
"Look what happened when the Hunt brothers bought a huge position
in silver. Volker took them down with extreme prejudice."
Well, time did change. Nowadays, the FED chairman can print money but he is totally powerless against basic economic processes.
> "no MM Fund with only govt securities ever broke a buck."
>
> Not yet anyway. You may get your buck back, but it might not buy
> very much if every foreign government on the planet holding dollars
> decides to sell in short order, for whatever reason.
>
Agreed. Technically, the US cannot default. You WILL get your buck back. It will be wroth less.
Inflation is a real threat. I wrote an article about this - it is currently in my Instablog, awaiting publication, titled: "U.S. To Default On Treasury Bonds?"
Link: seekingalpha.com/insta...
>
> Remember, the green pieces of paper in your wallet are "Notes", not
> money. Legally they are an IOU from the Federal Reserve, which has
> been allowed to redeem them in other IOUs since the early 1970s.
> In fact they are pieces of green paper, worth little or nothing in
> reality. If worldwide confidence in the dollar ever evaporates,
> it may not be terribly welcome in free trade. (Think Weir mark or
> Zimbabwe dollar.) This is a risk everyone is forced to take every
> day unless you exchange the IOUs for tangible assets like gold, real
> estate, productive equipment, etc.
>
Smarty Pants - you make some valid points in your post. True, Dollars are not money. Was it Kevin Phillips ("Bad Money" author) who made that point ?
> Thanks for discussing the finer points Living4Dividends, I'm sure
> there are many readers out there who benefited by hearing different
> sides of the coin.
>
> Good fortune with your investing choices. May we all manage to prosper
> without undue hardship.
Thanks Smarty Pants, I appreciate the praise.
> yellowhoard wrote:
> "Look what happened when the Hunt brothers bought a huge position
>
> in silver. Volker took them down with extreme prejudice."
>
The Hunt Boys were trying to CORNER the market in silver. This violates core principles of free markets: no monopolies, no cornering of the market.
In the pre-depression era, the practice of cornering the market made the fat cats rich and the populace poor. You had your sugar trusts and your oil trusts (standard oil). This practice has been made illegal since the reforms of the depression.
The Hunt Boys were brought down because what they were doing was ILLEGAL.
You are on the right track. I consider gold a hedge against "the chicanery of goverments and the foolishness of central banks."
On Jun 05 05:34 PM History Buff 24/7 wrote:
> Mauricio,
>
> Good points.
>
> My own evolution has been as follows. Before 2 years ago, I knew
> nothing about gold as an investment asset. Two years ago, I ended
> up with a bit of physical gold, then got my feet wet with GLD and
> then GLD options. Made some money on GLD, made even more money on
> the options.
>
> Currently I have what I think is an adequate quantity of physical
> gold, and my brokerage holdings are in CEF and GTU. I have seen enough
> compelling arguments that have persuaded me that there is no way
> for GLD to have more than a fraction of their claimed holdings in
> bullion, and because of the counterparty risk I am completely out
> of holding them.
>
> And you're absolutely right. I don't trust the government. I don't
> trust any one or any group which has a great deal of power. I don't
> care whether they are governments, corporations, labor unions or
> terrorist organizations. Power has a nasty tendency to corrupt people,
> and the more the merrier.