Gold has witnessed a meteoric rise over the last 10 years. At $1,193 per troy ounce today, it is now up over 300% (15%/year) since the start of 2000. By comparison, the S&P 500 is down 24% over that same period. Oil is up over 170% (10%/year).
While gold may continue to trade up for some period of time, history predicts that when the gold run ends, it will end badly. That is to say that the fall could be fast and far. Since Nixon took the country off the gold standard in 1971, there has been only one other gold rally on the order of the current one. It began in Aug 1976 and peaked in Jan 1980. Gold increased over 700% in less than three and one half years to $825. Unfortunately for those who bought on the way up, gold proceeded to shed 64% of its value over the next two and one half years. Worse, for those who thought “it will come back,” it took almost 28 years for gold to eclipse its Jan 1980 high in Dec 2007. On an inflation adjusted basis, even the enormous recent run has only brought gold back to just over half of its Jan 1980 peak.
So, how does one determine when the end of the current gold bull market is near? No one knows. Many are buying gold as a hedge against anticipated inflation. But, inflation is nowhere near where it was in the late 1970s. Specifically, on an unadjusted basis, year-over-year inflation in April was 2.2%. That was largely in line with an average reading over the last 25 years and a long way below 8% to 14% readings being registered during gold’s last spike. While future inflation may be in the cards, it would have to increase an awful lot from current levels to justify the recent run in gold. And, it likely has an uphill battle against high unemployment and a Fed that is at least saying the right things.
Maybe the better question to ask about gold is whether, given its performance, there are better investments at the moment. On the corporate side, an ounce of gold will again buy the S&P 500. Before the recent run, that had not been the case since Feb 1991. And, with corporate earnings after tax (also plotted on the chart below) showing recent traction, there are good reasons to believe that the S&P is not overvalued. Addressing the inflation concern, stocks generally provide a good inflation hedge over the long-term. The risk right now, however, is that the European issues could put pressure on the corporate earnings which support the S&P.
Taking it all the way down to the consumer level, an ounce of gold will currently buy you about one year’s worth of gasoline here in the US. Specifically, it will purchase almost 430 gallons at Monday's $2.86/gallon. With data available back to the early 1990s, that had not happened prior to the last two years. A very quick, very informal survey of non-money managers who live near me failed to turn up any people who found an ounce of gold more valuable than one year’s worth of gas for their cars.
Translating that to oil, a commodity easier to invest in than retail gasoline, an ounce of gold will currently purchase 17.1 barrels of crude oil (Cushing, OK). Since the start of 2000, that number has averaged 10.8. (Interestingly, it averaged 18.6 from 1983 to 2000, but that was before China and others made themselves felt as growing global consumers of oil.) More importantly, oil is a key consumable of the growing global economy. Unlike gold, it is easy to point to fundamental economic activities that are likely to continue to drive demand and price for oil up regardless of market vagaries.
One strange correlation that has crept up in the last 15 years that might continue to support gold prices is the relationship between the direction of gold prices and the direction of US debt to GDP. US debt to GDP peaked in 1995-1996. When it began to turn down after that, gold prices headed down as well. When debt to GDP bottomed in 2001 and began to trend back up, gold turned as well. Both have been on a steady march up since then. Unfortunately, the Obama 2011 budget has debt to GDP steadily increasing over each of the next 10 years.
Nonetheless, with a growing global economy and current relative prices, oil is likely to be a better returning investment over the medium to long-term.
Disclosure: No positions
