Is Gold Ever An Investment?

Apr.10.12 | About: SPDR Gold (GLD)

To know the answer, we must establish what separates an investment from mere speculation.

The world is filled with meanings for investment, with the most commonly accepted being Graham, Benjamin and David Dodd's "putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time." However, I'd hazard that much more distinctively, an investment is a deployment of capital into an asset, where the asset itself is expected to produce a positive present expected return/value, as opposed to speculation, where there is a deployment of capital into an asset, but the return is expected to be received by selling the asset to some other investor.

Now, using this definition, what sets apart an investment from speculation are two things:

  1. The asset needs to produce returns by itself;
  2. The returns the asset produces need to have a expected present value in excess of the cash needed to buy it.

This actually means you can invest in blackjack or in lottery tickets. As long as you have a positive expectation, that is, you have odds good enough or pay low enough, that the present value of putting money into blackjack or lottery tickets, is positive.

On the other hand, looking at an investment this way, gold (GLD) is almost always not an investment. It is always speculation that someone else will take it off your hands for a greater price, and hence a speculation. Why? This is because if you let gold sit there, it won't produce any kind of return by itself. It won't pay coupons; it would produce profits or anything else.

Another way of looking at it

An investment doesn't need a market for the assets you invest in. Theoretically, you could buy some stock, or bond, and still get a positive return out of it, just by collecting interest or profits. This would be true even if the market closed the day after you bought it. Not so with gold. If there isn't a market for your gold, then it's as good as worthless in terms of producing any returns. Yes, it might still be accepted as money, but that's different from calling it an investment …

… Except

Indeed, there is an exception. Money isn't an investment either. Unless, that is, you lent it and charge interest. Then it becomes an investment - and it also becomes a different asset: A loan. It turns out that gold can be borrowed/lent as well, that's the main way central banks turned gold in their vaults into investments - by loaning it out at a cost.

But can retail turn its gold into an investment like that? For physical gold, it can't. For something like the GLD ETF or iShares Gold Trust (IAU), there might be a way, though not all brokers will give you the benefit. Basically, when someone borrows GLD shares to short, he has to pay a small net charge for the opportunity, and whoever lends the stock could - if he was using a broker which would let the money reach him - get that small fee for lending the shares. This is the so-called short rebate, and it stands at a net negative 0.25% today for GLD, which corresponds to a 0.42% fee for the trader lending the shares. IAU isn't much better at 0.45%. Very little, as we see, and not enough to justify holding GLD or IAU just to charge it, so not enough to call GLD an investment on the grounds that it could, indeed, generate this income.

Conclusion

Gold is never an investment; it's always a speculation, a pyramid of buyers. If you had no market to sell your gold into, it wouldn't produce any kind of return and would, in effect, be worthless. This does not happen to stock in a profitable company or bonds, where even the lack of a market wouldn't impede them from producing returns. Knowing this should give you pause when thinking of joining the pyramid today, after years and years of piling speculative block upon speculative block.

To an extent, the same thing can be said of silver (SLV), except that given its industrial use it might not need continuous speculation to hold its market value. The same can also be said of companies where there is no clear path toward producing a present expected value in excess of what they trade for, except expectations can vary wildly from trader to trader, so there might be those who truly believe they're putting money into something as an investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.