Choosing Between Gold and Stocks and Deciding Whether Economy or Inflation Are Key

Includes: AGG, DIA, GLD, QQQ, SPY
by: Bachar Samawi

During the past few weeks stock markets around the world plummeted while gold prices soared. Should you also sell equities and buy gold?

It is important to note that from an absolute long term perspective, both stocks and gold can actually appreciate. At the same time, both assets can have short term fluctuations in either direction. What matters most is which asset is most likely to outperform the other in the long term.

If you had invested $100 in 1980 in S&P 500 stocks, your Total Return inclusive of dividends and reinvestments would make your $100 worth more than $2,600 today. Had you made such investment in 1960, it would have grown to about $10,000 today. Meanwhile, had you invested $100 in gold in 1960 at the spot price of $35.27 per ounce, such investment would be worth over $5,000 today. Hence, had you bought spot gold in 1960 instead of stocks, although your investment would have soared to $5,000 today, it is still half of the $10,000 you would have made in equities.

A longer term picture tells the same story. A $100 investment in gold in 1880 at the price of $18.94 per ounce would be worth over $9,200 today, while a $100 investment in stocks in 1880 would be worth over $77,000 today.

Although historical performance is no indication of future performance, such findings covering 140 years of history are quite impressive. Hence, today's gold rush must be primarily driven by short term uncertainties and intermediate term expectations for the economy and inflation. This is very counter-intuitive; most investors who buy gold point to its "long term" value, and yet, equities have proven to be a better long term value!

The past 140 years of history have witnessed World War I, World War II, the rise of the U.S. to a Superpower, the Cold War, the Great Depression, multiple recessions, the Gold Standard, the Gold Exchange Standard, Breton Woods, Nixon Shock (taking the U.S. off the gold standard), oil shocks, the industrial revolution, the digital revolution, soaring world population, Russian debt crisis, Lehman / Enron / Long Term Capital collapse, and more ... Hence, plenty of events and force majeure have tested stocks ...

How about the recent downgrade by S&P of U.S. debt? Isn't that an event that has not been tested historically? Such event can actually ultimately have positive effects, as was discussed in the previously published article "5 Reasons Why the S&P Downgrade of U.S. Debt Will Ultimately Boost Economy, Stocks."

A slowdown in the economy would curtail corporate revenues. A rise in inflation could also lead to a tightening in monetary policy and a short term economic slowdown. However, an economic slowdown would also force corporations to strive for higher efficiencies and product creativity. A rise in inflation would also lead to an appreciation in asset prices, including housing prices, which would ultimately help consumers recoup their equity and expand their spending. Such typical business cycle events are actually healthy for longer term growth.

Although the economy and inflation can have short/intermediate term effects on the attractiveness of stocks vs. gold, it is quite hard to make a long term case ...

Disclosure: I am long KFT.