The Myth of Gold as an Inflation Hedge

Buyers of gold in 1980, when the metal was 'hot' and inflation was rampant, were told that the precious yellow would protect their buying power over time.

Was that true?

The average price of gold was $612.56 that year and $610.00 twenty six years later in 2006. How much did the dollar's buying power decline in those 26 years?

From the 1980 average price of $612.50 gold declined to an average price of just $272.22 - or (55.56%) when it bottomed in 2001. Twenty one years of no income and capital losses.

Don't believe today's commodity crazies that would have you load up on tangibles right as they are at all-time highs. Learn from the past to avoid repeating the errors of past generations.

Year.......Average New York Market Price

(U.S. dollars per fine ounce) prices are not inflation adjusted.

1980 ................612.56
1981 ................459.64
1982 ................375.91
1983 ................424.00
1984 ................360.66
1985 ................317.66
1986 ................368.24
1987 ................447.95
1988 ................438.31
1989 ................382.58
1990 ................384.93
1991 ................363.29
1992 ................344.97
1993 ................360.91
1994 ................385.42
1995 ................385.50
1996 ................389.09
1997 ................332.39
1998 ................295.24
1999 ................279.91
2000 ................280.10
2001 ................272.22
2002 ................311.33
2003 ................364.80
2004 ................410.52
2005 ................446.00
2006 ................610.00
2007 ................702.57

Disclosure: no position

Comments

[cheapybob]

IMO, Gold will eventually catch up with the printing presses.

[gigem77]

Gold has more than tripled and crude has quintupled since 2000 while the dow has struggled to break even and the nasdaq is still cut in half. Don't let the stock crazies load you up with underperforming paper during the biggest commodity boom in history. The planet is adding 75 million new consumers every year. Got copper? wheat? oil?

[sdavid0419]

Here here Gigem77. I bought the drug companies after the run up and watched them go sideways for years. The answer is to buy low and sell high. I bought my gold while it was low and have sold some as a hedge but believe there is another third upward at least for the rest of my investment.

[electraman]

The events unfolding in our economy today are not the same as the '80s. It's like comparing apples and oranges. The credit situation and inflation today is unparalleled in history. Us 'crazies' will have the last laught, so go ahead and throw your money into a rigged market. One last thing, please publish a balanced story to this blatant attempt to knock down gold.

[David Lentz]

If this was a "blatant attempt to knock down gold", it's succeeding far better than anyone could have believed!

More likely is the possibility that gold is a highly volatile (and emotional) commodity, with no more inflation resistance than any other commodity -- possibly less, due to all the attention focused upon it.

And rather than looking at the price of gold from the prior peak (1980) or low (~2000), it might be helpful to look at a chart of gold vs the dollar over the past hundred years or so. Then I think one would see that if there is a correlation between the two, it is not a very strong one.

[David Lentz]

BTW, electraman -- I find the events in the economy of the late 1970's (oil prices spiking to record highs, the economy feeling the impact of government spending on foreign wars (Vietnam was heavily deficit-spending funded, and took the economy years to recover from), recession) eerily similar to those of today. Looks to me more of a case of comparing oranges to tangerines.

And if there is inflation, show it to me in the money supply numbers, please -- don't just rant about it. Rising prices does not equal inflation.

Mish Shedlock (and others) have repeatedly demonstrated that there is no overt expansion in the money supply, that the real danger is that the Fed is not able to create credit as fast as it is being destroyed, and we will slide into deflation.

[Pent updemand]

Right, no overt expansion of the money supply, just plenty of covert action.

[bearfund]

The long-run divergence between M1 and M3 growth rates is the real worry. Creating more credit does in fact cause prices to rise, stimulated by leveraging even if no actual money is created along with it. But at some point (like now) there will be far more credit outstanding than there is money to service it. The two are linked by a rubber band; the farther apart they get, the more violent the readjustment is when they're forced back together. That can take the form of credit destruction or hyperinflation. The Fed's answer appears to be to accept neither but instead try to offset the destruction of credit by creating more, leaving the rubber band with just as much tension in it as before. You may be surprised to learn that I am rather skeptical of this approach.

There are two things any investor interested in gold should look for in an article about the metal. One is a chart or table of prices starting in 1980 or any comparison of today's prices to the 1980 price, inflation-adjusted or not. The other is anything about the 1933 confiscation or anything with religious overtones. Articles with either feature are intended not to educate or inform but to inspire emotional reactions that lead to unsound investment decisions.

Instead of 1980, for example, this chart should begin in 1974, when Bretton Woods completed its collapse and the modern gold market opened. After all, if I wrote an article on stock prices and started my chart in 2000, you might well be tempted to conclude that stocks are a terrible investment all around. But that would be dishonest; the modern stock market has been around in more or less the same form for much longer. That's true of the gold market as well. If you want to make a point about market conditions during a particular interval (since 2000, stocks have been a pretty lousy investment; from 1980 to 2001, gold was a pretty lousy investment), that's fine. But cherry-picking starting points is just dishonest.

[Tim Price]

The tone of the piece suggests that investors can EITHER invest in gold (an asset whose value is not contingent on anybody else's ability to pay and which even Alan Greenspan has conceded, in extremis, still represents the ultimate form of payment, while fiat money is accepted by nobody) OR in stocks and bonds, but not both. So much for a balanced portfolio. For sure, speculators seem to have been taking profits (and/or paying for other leveraged losses) in recent weeks by selling gold. But some of us are perfectly happy to own an asset that has been a store of value for over 2,000 years. That puts the acknowledged volatility of one month or even two-and-a-bit decades into a somewhat broader perspective. Particularly when most international banks are probably technically insolvent, and their shareholders should be unsurprised when they are diluted out of existence.

[GaryD]

Why do you inflation adjust the price of gold, but you don't inflation-adjust the price of money? Your analysis makes no sense. Why do you start in 1980 when gold prices had spiked? The proper starting point for the analysis is 1971, when the US was taken off a gold standard. You have chosen a starting point in your analysis that leads to the conclusion that you set out to prove. My friend calls this "the completion backwards principle". It's a telltale sign of a dishonest analyst.

[DrBagel]

Gold is money. It is the final common money in our society. It will always be accepted and it will always have value. That does not mean, however, that it will always maintain its value or appreciate in a given time period. Investing in gold has a cost. The opportunity cost of missing out on going concern investments, driven by profit margin and adapting to the economy as it changes. In such, a long term bet on gold is a cash position and an overall bet against the financial markets. I'm not sure I want to take that bet. I will use it as a hedge, though.

[gigem77]

The money supply is growing at double digit rates. Here is one chart of MZM from the St. Louis Fed. research.stlouisfed.or...
John Williams says the growth is 16% www.shadowstats.com/al...

[TonyC-SA]

Well, isn't this ridiculous? Why start in 1980? Why not in 1985, it is up 120% since then. Why not inflation adjusted?

In 1980 we had the most inflation since 1940 or so, and that is why gold was high. The CPI was 100 in 1982-84, and it is currently around twice that, indicating the value of the dollar has HALVED since then. GOLD has indeed been an inflation hedge, you cannot talk about gold as an inflation hedge being a MYTH without taking inflation into account! Nobody is claiming that it is some great investment, the only claim is that it holds it value when dollars are in decline, so it is at least a safe harbor. And if Newmont Mining is to be believed, it is getting harder to find and reduced supply with increased demand is going to make it an even safer harbor.

[TonyC-SA]

FYI, look at this CPI chart on wiki. It isn't hard to find this stuff.

en.wikipedia.org/wiki/...

[Schippi]

Gold as an inflation hedge has worked for all of recorded history. Also history shaows that all paper currencies have failed. Since Aug 2007 to date. BVN ( +100% ), GLD ( + 34% ), SP500 ( -3% ). As for the U.S. Dollar it's chart looks like Niagara Falls.
Schippi

[eric hart]

Bearfund,
You make some excellent points.

Why does gold investing split people emotionally into two camps?

Its a commodity, its a metal, its an asset, its a store of value, and its mostly negatively correlated with the other markets made out of paper.

Why not own some paper and some metal both?

It does well in times of rising inflation, like now, and poorly at other times.

A well known fact, but underreported one, is the well orchestrated efforts of the worlds central banks to keep the price of gold artificially low.

Therefore, it does make some superficial sense to point out that gold has been a relatively poor investment and "barbarous relic" since 1980.

But, why not since 1971, as others have said?

How is the use of historical price data not a reliable indicator of the future potential?

Because US, UK (Gordon Brown), and EEU have been systematically selling hundreds of tons on the gold markets yearly to lower prices.
And they do so at a loss of future price appreciation.

They do so to suppress the price to placate inflation expectations of the public--and lately this has been ineffective.


I frequently shake my head at the "shooter behind the grassy knoll crowd". I don't think most conspiracy theories pan out--a simpler explanation can often (tho not always) be found.

But in this case, the theory that world governments artificially suppress the price of gold--it's really out in the open (mostly).

Gordon Brown dumping approximately half of British gold reserves at the low is but one of many examples.

Eventually they will learn, or run out of gold. Furthermore, the reporting of the CPI itself is artificial and erroneous. Real inflation is closer to 8-10% than 4%...and it has been for many years.

Governments provide bogus inflation numbers to control costs in their budgets and have an essentially free lunch.

As bond investors and the fixed income crowd wake up over the next five years to the stealth tax of inflation--they will pull money out of bonds when they can. Some of that money goes into TIPS, some into commodities, some into other assets.

Finally, the inflation adjusted price of gold is NOT $2200 or so as reported in the media...it is closer to $4000 plus.

Why the discrepancy? Because the media is using official government statistics. See: Shadowstats.com

I am a skeptical reader of the site, but its basic premise is correct. Inflation is vastly underreported.

[eric hart]

See also: financialpost.com/stor...

[MattBlackman]

Check out the link to MZM posted by Gigem77 for the real story on money supply. As of the latest Fed figures, total money supply has increased 17% in just 15 months and is now growing at a annualized rate of 39%.

Ben Bernanke wasn't kidding when he asked a couple of years ago why we should worry about deflation as long as we had printing presses and helicopters. It is clear he now running both at combat speed! Certainly no reason to expect the dollar decline to end anytime soon.

Kinda takes the starch out of Price's anti-gold argument doesn't it?

[cbellison]

From the Board of Governors of the Federal Reserve System: (M3 in billions, average)
97 - 5,224
98 - 5,765
99 - 6,270
00 - 6,860
01 - 7,648
02 - 8,259
03 - 8,787
04 - 9,234
05 - 9,786
06 - not available

[ChrisG]

Wow, this is the most distorted, disingenuous analysis I've seen on this site. As others above mentioned, cherry-picking the time frame starting at Gold's all time high at the end of the 70's stagflation to fit the argument is a joke.

In regards to gold price suppression by central banks, take a look at the gold lease rates: www.kitco.com/images/l...

Yes, the short term rate actually went negative! Central banks are literally paying out to encourage borrowing (and dumping onto the physical market) of their gold.

[Saint Xinon]

Gold has 3 advantages:

1> You do not have to write "In god we trust" on it.
2> Governments and time can come and go people on planets have faith in it.
3> In case of sudden banking and financial system failure it is only accepted money.... ask people from Indonesia ....

Rest is paper and wires and promises.....

[johngonole]

The "In God we Trust" part is about the only positive thing about our FIAT currency. Remember the GWT was on their before it was taken off the gold standard also. Trust is what the Federal Reserve is destroying. Don't blame God.

[Trelvin]

When you increase M1 substantially, you increase the velocity of money-the number of transactions--so it is that opportunities are created to RAISE prices before the next transaction takes place.-and buying Gold, knowing that it's price upward just reflects that, means a new "bubble" can form -- all those holding who realize suddenly that someone now is about to make the next transaction.
The bet is that speedy transactions will come to gold but those transactions may not go into gold if value is found elsewhere. So banks selling gold to create value is not a bad idea; until velocity tanks the price on its own when that is perceived as its only intrinsic worth. Would you carry gold and water in the desert for very long?

[TonyC-SA]

TRELVIN: >>> Would I carry gold and water in the desert for very long?

WHAT? As to water, YES. As to gold, yes. Somebody might trade me food or more water or shelter or transportation for the gold, so I doubt even a pound of gold coins is going to make a huge difference in how far I can go in the desert. If I can only choose one, I'll take the water, but that (as is pointed out in a post above) is a false choice, we can split our investment money pretty finely.

Also, I disagree with the idea that velocity represents the "intrinsic worth" of gold, it's intrinsic worth is in its rarity and as an ingredient in its inherent elemental properties that cannot be duplicated. It is not just jewelry and its value is not entirely due to some sort of psychological quirk of humans. As for velocity, I don't care a whit how often others are trading gold or whether there is an "opportunity"... to raise a price, and I don't know any serious investor that does. My only opportunity to raise the price is when **I** sell what I have. I agree that liquidity is an important consideration, and very active trading is a clear indicator of assymetric information (and a bubble when one side of that information is just mistakenly optimistic). But such indicators are not predictive of prices, they just warn you to pay attention and find out what it is you don't know, and correct at least what may be a personal information deficit.

[RealtorBOB]

But I would rather look at gold than paper. Neither one has any intrinsic value !

[User 173189]

Why don't you choose another start year, like 1960 and see that gold DID protect investors against inflation ? Following your method I could also 'prove' that stocks are a bad hedge against inflation. Whoever bought the Nikkei in 1990 at 40.000 is losing almost 67% after 18 years. Something similar could be said for the Nasdaq, don't you think so ? Pretty biased article this one !