Gold: The Worst Inflation Hedge Ever

Includes: GLD
by: Skyler Greene

Q (reporter): A lot of people used to talk about gold as a big inflation hedge, but do you think stocks -- equities are the best inflation hedge?
A (Donald Yacktman): Much better long term. Gold, it's a supply-demand, it's a commodity that other than psychologically -- and gold has some uses, jewelry and teeth and so on, but it's not a practical thing. I'm not enamored with gold, I'd much rather own Coke and Pepsi.

- Interview with Donald Yacktman, March 2012 (video here)

It's no secret that Warren Buffett isn't a fan of gold, but I wasn't aware that my favorite stockpicker (Donald Yacktman) held the same opinion.

I've previously discussed why gold bullion isn't much of a safe haven and would be as worthless in a real apocalypse as ETFs like GLD. While gold as an asset has produced phenomenal returns as of late, the point is that in the long term, gold doesn't really qualify as an "investment." Why? Well, a cube of all the gold in the world (~$10 trillion) will pretty much just sit there until the cows come home. Warren Buffett's (quite witty) analysis sums it up this way:

As for its merit as an investment, Buffett observes the following:

  • The cube of gold will produce nothing in the next hundred years (or, for that matter, thousands of years).
  • The cube of gold will not pay you interest or dividends, and it won't grow earnings.
  • You can fondle the cube, but it won't respond.

If you had $10 trillion sitting around, Buffett further observes, instead of buying the cube of gold, you could buy all the cropland in America ($400 billion-worth) and 16 Exxon-Mobils. And you would still have $1 trillion of "walking-around money."

Over the next hundred years, your cropland and Exxon-Mobils would produce trillions of dollars of dividends (the size of which would be adjusted for inflation), and you would still have them at the end of the century, at which point you could probably sell them for vastly more than the $9 trillion you bought them for.

So, which investment would you choose?

It's pretty clear from the above analysis that gold can't really be classified as an "investment," because it can't reasonably be expected to grow into something bigger and better in the future. Why, then, do people buy gold?

As revealed by the reporter's question to Donald Yacktman, many people buy gold as an inflation hedge. The argument goes something along the lines of "gold has an intrinsic value" and that intrinsic value should remain fairly constant over the long term, so gold will protect you from purchasing power erosion.

Well, there's just one problem. If you look at the following two charts, you'll notice there's not really a whole lot of relationship between gold and inflation. While inflation kept on going through the '90s, gold kept declining. Gold's recent rally has occurred during a time period where inflation actually dipped below zero and then stayed at levels lower than/comparable to anything seen in a decade. (Data is from about 1975-present, after Nixon canceled gold-dollar convertibility.)

Click to enlarge

The "intrinsic value" argument of gold gets even uglier when you look at gold's inflation-adjusted price. Gold purchased in the late '70s and held until the late '90s lost about half of its purchasing power. I haven't seen a hedge this bad since JPMorgan lost $9B on a hedge to a hedge to a hedge, or something. Nobody's really all that sure what it was doing, but it sure can't be called hedging. Point is, hedges are supposed to actually hedge against something -- and gold's inflation adjusted chart shows that it didn't really do a great job of that one.

Click to enlarge

And if inflation numbers are inaccurate, as many claim, then gold's relationship to inflation is even more volatile.

So then what the (bleep) is gold? It's clearly not an investment, and it's clearly not a hedge.

What gold is is a fear asset. A lot of times, when people are scared, they'll turn to gold (and occasionally silver) because they view precious metals as "safe havens." But as Donald Yacktman said, gold has no intrinsic value. It's all psychological. When you have enough people thinking gold's a good investment (like now) then it goes up.

Therefore, gold boils down to a speculative asset. It won't grow like a traditional investment, and it clearly doesn't do so well as an inflation hedge. It can, however, jump in price for little apparent reason. If you have a sizable portfolio and you want to speculate, go right ahead. The fundamentals for a gold rally (loose monetary policy = fear of inflation) are still in place. But if you're buying bullion as a long-term wealth store because others have told you it's a good idea, please stop. It's a terrible idea. Just look what happened to anyone buying gold in 1980 -- they saw 20 years of dramatic price depreciation. If you're worried about inflation, buy TIPS (when yields go up, not now) or equities. Over the long term, either of those will act as a better inflation hedge than gold.

Disclosure: I am long SLV.

Disclaimer: I am an individual investor, not a licensed investment advisor or broker dealer. Investors are cautioned to perform their own due diligence. All information contained within this report is presented as-is and has been derived from public sources & management. Always contact a financial professional before making any major financial decisions. All investments have an inherent degree of risk. The future is uncertain, and actual results may be materially different from those expected. Past performance is no guarantee of future results. All views expressed herein are my own, and cannot be interpreted as the views of my employer(s) or any organizations I am affiliated with. Presentation of information does not necessarily constitute a recommendation to buy or sell. Never make any investment without conducting your own research and reading multiple points of view.