Gold as an Investment? Think Again 43 comments
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The bulls may feel frustrated as gold draws on the $850 mark, kind of like the frustration felt by those who bought in at around the $800 mark in 1979. Not that I am implying that this is the turning point, or that I am shorting the precious metal, but it is important to analyze the historical under performance of gold as an investment. This article is intended for those with significant exposure to the yellow metal.
The same arguments will always hold in the bull camp. Governments inflate money, gold production is dwindling, gold will return as a form of money, and the ever popular idea amongst gold bugs that we should return to the gold standard. Unfortunately, I don't have time to say everything that I want to say today, but I will definitely address all of these points in future articles.
In this article I hope to accomplish 3 things:
- Let's look at the big picture of gold as an investment.
- Following this we will analyze the past 10 years in brief
- Finally we will look at the prospect of holding gold for the future
Gold as an Investment
If you buy gold because you are a U.S dollar bear, you are really just a dollar bear, in my opinion, and not a gold bug. And while many people are in fact dollar bears (and quite justifiably so), most do not rush straight to gold - as has been the historical case.
Let's look at a popular alternative. Instead of buying gold over the past several years, you could have simply put the same money into a euro-denominated high yield savings account or an ETF such as CurrencyShares Euro (FXE). Not only would you have seen remarkable capital appreciation versus the dollar, but you also would have earned around a 4% yield.
Compare that to the holding and insurance cash outflows of gold, and you can immediately see the benefits of an interest yielding asset. Staying on the theme of currencies as an alternative, there are still many responsible central bankers left in the world. Consider the Reserve Bank of Australia who has been raising rates for quite some time now to combat inflation. Once again, great capital appreciation AND CurrencyShares Australian Dollar ETF (FXA) now has yields sitting at 6.78%. Besides for currencies, there are many other hard asset alternatives, and although housing is usually one of them, its obviously not this time around.
click to enlarge image
Looking at the chart above, we can see that gold's performance has been anything but consistent over the past 30 years. The cries for gold to reach its inflation adjusted highs are quite absurd considering that the precious metal has always lagged inflation; why should it be different this time around?
Considering that gold is an alternative to cash, not yield producing assets, this statement makes perfect sense. The weighted average increase in the purchasing power of cash, bonds and stocks will ultimately put cash (or gold) below the long term average. Reward comes from taking a certain amount of risk and the effective allocation of capital, not from leaving the capital in your safe.
In addition, keep in mind when looking at the chart above that about half of the return from the DJIA is actually in the form of dividends and is not reflected on the chart. Compare that to gold, where the past 30 years have likely seen billions wasted on gold insurance which includes storage and security costs.
Warren Buffett on Gold:
It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
That stream of dividends is fairly safe, with little volatility (not that the long term DJIA chart looks too volatile in any case), and is a result of economic value added. If we want to talk about long term investments, being vested 100% in equities is the way too go. Obviously short term volatility becomes an issue, as well as the need to spend money along the way, so a person's portfolio should consist of a cash component that may or may not have a percentage of that in gold.
After breaking it all down, gold should not be more than 2-3% of a persons target long term portfolio. As Peter Bernstein correctly pointed out, a very small holding of gold is great insurance of a big catastrophe. However, in this author's mind, that insurance does come at an opportunity cost.
That being said, gold will gain value in certain scenarios, as it's done in the past 10 years
Gold Over the Past 10 Years
Gold has made a remarkable climb over the past 10 years. Will it continue? Let's look at some of the events that have contributed to this:
- The Asian Financial Crisis
- The Dotcom Bust
- September 11 Terrorist Attacks
- Iraq War
- Global Terrorist Attacks
- U.S Housing Bubble
- Skyrocketing Oil Price
No wonder gold, the asset considered to be a safe store of value, has become so popular. Jon Nadler of Kitco said in an article about a month ago that the bugs who see $5000 gold are expecting something so bad that they are better off buying lead, for bullets, because that will be far more valuable than gold. Consider the events that propelled gold up 300% over the past 10 years. If you believe, as some of these bugs do, that this is nothing compared to what we will see in the next 10 years, then maybe you should buy gold.
However, speculation of what the future holds aside, this looks very similar to the 70s. Food and energy crisis, war, and inflation. I'm sure that those who bought in the $800s back then saw things getting twice as worse in the next decade. Then what happened? Possibly the greatest economic boom the world had ever seen.
Looking Forward
To re-iterate, gold is cash, it's riskless, it doesn't work to produce further capital. When you look ahead, what do you see? Do you see oil running out and global war breaking out? Buy lead in that case! I am less pessimistic. I have always believed that the ingenuity of the combined human brain power can solve any problem critical to our existence.
So where do the real returns exist over the next 30 years and why don't you want to be invested fully in gold? Simply put, opportunity cost of capital. Next time that you want to buy another ounce of gold, ask yourself, is there anything in China growing at a rate slower than 10% per year? When will we discover alternative energy? How significant an effect will widespread computer usage have on the micro-economic picture and business productivity as a whole?
These are just a few factors that will likely produce great returns over the next 30 years. On top of that, consider that most of the really big societal changing events cannot even be conceptualized before the fact. However, being diversified across all industries will undoubtedly give you some exposure to the next big thing without having to play the guessing game.
If I am right that the next 30 years will see marvelous scientific discoveries and that expectations of war and famine are overblown, those that hold gold will be punished for wasting valuable capital that could have otherwise served a real purpose.
Lastly, I just have to point out that gold could possibly return to its highs of two months ago, but should that happen, and should the market continue to force it up, $100 drops in short periods of time will become characteristic. It's hard to call the top of a bubble.
As I write this article, you are seeing gold buy recommendations outweigh sells by as high as 100:1. Every man, woman and child is telling you to buy some. Could it be… a bubble?
Disclosure: none
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This article has 43 comments:
If the economy gets bad, then people will buy less of each meaning that there will be more gold available for purchase thus driving the price down.
Sure, costs to mine it have increased but how do you figure that into a rising price for a commodity that isn't in demand for anything necessary to produce (luxury items) in a bad economy.
Lastly, I also mentioned I'd rather have a couple of HK MP5's and crates of bullets in their 'global war' scenario that they insisted was around the corner.
Picture it... global war. 'Hey buddy, got some food? I'll trade you some soft yellow metal that is real purty'. Blam**** 'Thanks for the gold you idiot'.
Do we need to mention that if we really have a global financial melt down, that gold they bought is ... somewhere.... so how would they trade it?
People just haven't figured out that we are off the gold standard yet. The only use of the shiny yellow metal is in production of certain products and the price should reflect the demand for those products.
I'm a gold bear because there is no way there is enough folks who still buy into the gold bug theories to really push the bubble it was any higher.
The recent volatility will force the weak minded folks who bought just because it was up to the sidelines and they will be fearful of buying back in. These are the folks who are investors and got fooled by the hype. They won't make that mistake again.
BTW, thanks to the author. It never crossed my mind to invest in those foreign currency indexes. I'm going to keep my eye on the economy and maybe put a few bucks into them.
Look around you... can you make enough bullets for the global crisis? I'd bet you can't even make 1 with the amount of lead you find in your neighborhood.
You also need to do some more research. There is much more gold than 2 or 3 football fields. Much much more.
Regardless, I would want bullets and farmland when the big one hits. Keep you gold and don't bother trying to trade me anything for it. I'll just laugh. What the heck am I supposed to do with a soft pretty metal when people are hungry and fighting for their lives.
Of course, if you aren't one of those doomsayer gold bugs then please refer to my earlier argument stating it's just a commodity that is used in luxury items.
Re the total quantity of gold, you are wrong. There are many estimates, many of which indicate all the gold ever mined would fit in a cube 100 feet x 100 ft x 100 ft. No one knows for sure, but if anything, 3 football fields is on the high side. The total gold ever mined is estimated at 145,000 tonnes, equal to $4 trillion in value for gold at $1,000. Note in comparison that the S&P 500 has a total market cap of 12.6 trillions. So imagine the flight to gold that may take place if the equity culture vanishes for 10 or 20 years.
Finally, gold is one of the few things that are indestructible. Rare, indestructible, and also pretty to look at. Much better than most stock certificates :)
The author is correct that gold is not an investment, but rather a sort of insurance policy. Insurance against what, though? Insurance against debasement is the answer and since the bursting of the tech bubble we have seen debasement accelerate at an alarming rate. This is why people are buying gold - not because of visions of armageddon. And so far they have been right. Were it not for generously massaged financial stastics coming from the government there would probably be a lot more flight to gold as people would realize that inflation is probalby running close to 10%.
Think of it this way; Say you are a retired little old lady with $1,000,000 in the bank earning 5% a year, netting you $50,000 (pretax, of course) to live on. If inflation is running at 5% a year that is the equivalent of 100% tax on your earnings. If inflation is running at 10% a year that is 100% tax plus another 100% in penalties for having the audicity to save rather than consume.
Don't be fooled by nominal stock market returns. If you bought the Dow on Jan 1 2000 it would have to be 14,184.39 today just for you to have broken even in real terms. And that is using the "official" government CPI with all of its "adjustments". If inflation was calculated using the pre 1980 methodology that number would be closer to 20,000. Still think the stock market is a great deal? How long do you think it will be before the REAL returns on the Dow get you back to the levels of 2000?
ding ding ding!!!
2) The past 30 years are actually more appropriate than the all time movement of gold. In the 70's, it was the USD or gold, you weren't exactly running to stick your money into Chinese Yuan. Looking further back than that, gold was fixed, and before that, gold was very important in trade as a form of money. So now we have stable alternatives. My argument is that escaping the USD will be absorbed through the variety of alternatives instead of a concentrated blow on one asset, which has historically been gold.
3) YES! The USD is being debased, look at the USD index! Yes gold may rise in USD terms to $1500 or $2000. My argument is that because of the relative benefits of being in a currency like the Euro, a 100% rise in gold from USD weakness will be met with a 100% rise or more in the Euro. REMEMBER: You can't just look at the chart. You have to remove storage and insurance costs from gold returns and add in interest received from Euro deposits. You are more beneficial being in a yielding asset where the capital has mobility and is being used constructively.
4) The lead thing got a little out of hand. I'm not talking on a supply and demand basis, theres no in depth financial analysis here. It's simply a commentary that if things got that bad you wouldn't be sitting in monte-carlo! You would be huddled in a cave somewhere, if you're lucky to be alive. You could have a stack of gold behind you, but at that point you would trade all that gold for a gun and some food to protect your family.
Best!
Measure any index or asset against gold for the last 8 years, weather it's the DOW, S&P 500 etc. and gold has been a great alternative. I agree, for most people, it is a great insurance, best taken is small portions, due to it's apparent short term volitility. However when you take the incoming tide ( e.g. last eight years ) it can be a great investment, as long as you don't get shaken out at the wrong time.
Of course gold ( and silver for that matter ) are unique in many ways. Physically it's high value for it's size, it's transportability, ease of acceptance throughout the world, it's almost indestructable (noble) properties, makes it quite different to other commodities. It's unique history as a currency, it's beauty and safety in handling add to it's uniqueness.
Also it's no one's liability, unlike some of the alchemical paper instruments such as CDO's, SIV's and MBS of recent creation, that are currently being so severly discounted. It's a real asset, not like a bond, which is someone else's promise to pay, with an insurance fee ( interest ) in case they default.
Over the last eight years carefully managed porfolios of gold and silver stocks have also been stellar performers. They will continue to be great performers until gold is done discounting all the fiat currency machinations of the last 30 years ( or more ).
On other hand, those who worship gold as a religion have no more credibility than the Flat Earth Society.
or in the case of gold it has many hi-tech uses we Are Just Beginning to Understand, not to mention the ones we KNOW. It fufills all SIX classical criteria for MONEY. Therefore there are two views: ONE, gold is money and values everything else; TWO: gold is a commodity is valued in FLOATING currencies. Choose your weapon.
Someone told me they were concerned because the FED was doing injections into the system. My question was what were they injecting? : Crude Oil? Natural Gas? Potash? Wheat ? Rice ? Coal?
Heavy Residual Oil? Lettuce? Olive Oil? No the only thing the FED can inject is digital dollars....DIGITAL DOLLARS ! ! ! Now exactly what is a digital dollar and how can we get them? What is their utility? What does it take to make a Digi-Dollar? Does it take crushing 30 tons of rock and a like amount of water to make a Digi-Dollar? Or Eight Hundred of them ? Take your choice given that
we can crush rock to get gold, or push a couple keystrokes and make Digi-Dollars ! IF I had to trust a "Monetary Official" it wouldn't be with a keyboard that could create fiat money.
PLACES GENTLEMEN START YOUR DOZERS ON MY SIGNAL !!
DG
www.howstuffworks.com/...
Author mentiones 5 reasons why gold has gone up in the last ten years:
The Asian Financial Crisis
The Dotcom Bust
September 11 Terrorist Attacks
Iraq War
Global Terrorist Attacks
U.S Housing Bubble
Skyrocketing Oil Price
what crap....
Gold bottomed in 2001. Asian crisis had zero to do with this.
911 crash only is related to the rise of gold indirectly. Fed had to lower interest and let inflation run high and has continued all this time. All the reasons this outhor writes about are only indirectly related to the price of gold in the way that all these events forced the central bankers to print more money and let the inflation run WILD.
To the author, Nadler and all imbeciles who love to bash gold because it competes with the currencies and the market as a whole:
Gold is a call option on future inflation.
Nothing more nothing less.
Geopolitical crisis influence the markets a whole lot more than they influence gold. In time of geopolitical news gold gains few bucks and sells of the following few days. The only reason for golds rise in the last 7 years is INFLATION, percieved and real. Even Bernstein is mistaken thinking of gold as a catastrophic insurance.
If you think inflation has toped, than you sell gold.
Is the fed about to raise interest rates to curb inflation?.. Hell no. The opposite is the case. The fed needs to inflate for years untill the future obligations become managable. Think about that for a minute. Do you know the amount of UNFUNDED future obligations are. TRILLIONS....
I asure as long as this is the case, gold is going higher. And make no mistake about it, GOLD IS GOING HIGHER.
Now, your comparison with gold an equities. Hello stupid! Look at the 10 year chart of the S&P. you made couple of % anualized returnes at best while HUI is up over 1000%.
Oh, and your most idiotic argument of all, that gold is a bubble because everyone is invested in gold:
I am a financial advisor and I talk to hundreds of people on daily bases. They shiver at the thought of buying gold. This tells me that overwhelming majority of population still hasn't even begun to look at gold as an alternative. This means that gold has years if not decades to reach for the upside.
Why is gold so mystified, hated and missunderstood.: Central bankers with all their propaganda and financial might has created this stigma about gold and most idiots such as this author has played in their hands. Gold is a barometer of inflation and exposes the bankers to their tricks they use in impoverishing general populus. Inflation is A TAX ON GENERAL POPULATION!
Why do people such as this author feel compelled to vomit in these pages about a subject they lack the most basic knowledge of...its a mystery to me. I know we live in a free country and everyone can have their say, I just wish their say had a resemblance of real events.
Regards,
Troy
And with regards to the time frame, you proved my point. How can you compare gold today to when it was fixed? How can you compare the returns of buying gold while its fixed and selling it many years after free-floating? Moving forward the environment's characteristics will be more similar to the past 30 year period than the past 100 year period. If i was really trying to manipulate the data I could've gone back to the 70's and shown 0 return if you bought in the 800's.
2) Yellowstone - Gold bugs tend to make arguments that their predecessors made and that they feel are unchanged. You call gold transportable, yet in today's day and age currency is incredibly far more transportable. Gold held significance because it was small and light yet still valuable. Nowadays it's a hassle. There's also more risk in transporting gold across the world than sending a money order or a cheque.
Ironically people are accusing me of selecting a particular time-frame (which I believe I have defended well), and now I will do the same to yellowstone. Dotcom shares did tremendously leading up to the bust. Nothing did better than housing derivatives up until a year ago, and now nothing is doing better than gold. It may even continue to outperform in the short term. My argument is the long term opportunity cost of capital.
3) As stated in the article, my main focus is on those who have most of their money in gold. Those who's portfolio movement is explained largely by the movement in gold price. As stated in the article, a small holding can be a good insurance, but it's insurance, there's a premium to be paid. That premium comes in the form of lower returns when the market is functioning normally and the insurance comes into play when we have a run of crisis' like we've seen in the past 7 years. If they continue to compound on each other, gold will rise, but regardless of if you bought into gold or not, your standard of living will decrease substantially.
So to the gold bugs, keep praying for a nuclear war, I'm sure you won't be singing and dancing in the streets when it happens.
Also if it truly tracks inflation, why then would gold crash after the inflation of the 70's? Dollars had been debased, and we obviously know prices continued to rise after that, albeit at a lower rate, why wouldn't gold have leaped up and then slowly staggered up continuously. In fact, there's inflation every day as the printing presses are almost always running and the Fed is almost always active, so why wouldn't gold just move up continuously on a daily basis?
Mr financial advisor, HUI is an index of gold producers not of gold itself (i hope you make this distinction to your clients). Producers fill my yield producing profile and will have better returns than gold itself in the long run. If gold crashed, the producers would still make money.
Lastly, check out the COT reports. Not only are producers historically short gold, but the public is historically long (excluding ETFs). If you include ETF's then the public is definitely heavily invested in gold. But I guess your world of 100 people in the same socio-economic environment is a better indicator than the CFTC's reporting mechanism.
And when the time comes, and the profligate fiat games have gone to an extreme, gold, all by itself, will set about balancing the books and setting a fairer value to the paper fiat of the day.
It's a natural tide of nature, not to be feared or loathed, just to be harnessed while the re-balancing takes place. I would say the fiat nightmare created by the FED since 1913 is the real horror story.
Dr. Gold is making a house call, and is here for healing and restoration only.
You say you are a financial advisor, Troy. I hope you don't talk like that to your clients. I think a number of your arguments are valid. However, they are undercut by the language you use to describe those who disagree.
Finally to Adam: I especially appreciate your reading and responding to comments.
Go back ten more years and all of a sudden gold is a great investment. I didn't bother reading the rest.
You are referring to the adjustments made in the dow divisor which keeps the value of the index constant. If ABC is trading at $30 and they pay out a dividend of $0.50 (company value now is $29.50 + $0.50 dividend), then the divisor adjusts because the index is price weighted and it's value shouldn't go down because the company paid out a dividend and is now worth $29.50.
To think about it another way, the dividend comes out and the DJIA doesn't assume that it gets reinvested. If all companies retained 100% of earnings then this wouldn't be an issue because reinvestment would be assumed. Because of the exponential effects of the time value of money, it actually makes a substantial difference in the long run.
Reference: siepr.stanford.edu/pap...
Go back 10 years and you just see more volatility and another gold bubble.
Thanks for your input.
As 70% of gold is used as jewelry - what happens to the price when 500 million more people want to buy a gold ring?
Demand driven price pop-zoom-bang-whoosh!
god forbid hip-hop gold chains catch on in China!
PS - fiat currency up 17% last year in the US alone.
Euro is another FIAT currency. Dollar has appreciated enough against Euro already. Euro is not going to sit and take it until they are driven out of business. From now on, ALL CURRENCIES will Depreciate against the real money,GOLD.
From the tone of the posters, obviously the public is way underinvested in gold. It's funny how people hates gold, whereas they don't hate oil. They always go together. I would say, the government has done a superb job of brainwashing the dim-witted public.
some are correct to suggest it not necessary to hoard
gold, despite the fact that world governments take the lead in that selfsame pursuit of the "blaise blaise"
medium. That factor may have something to do with
the likelihood that no sane person would hope for any
catastrophy but unfortunately, we all know that practically anything beyond our power to influence can
prove a reasonable expectaction.
The purpose of this forum is to advise oneanother, to-
wit many do their best. Although I am no expert I do
recognize this, he who owns the goods may attempt to manipulate the price as he wishes. And further, re-
gardless to how outlandish that price may seem if the
populace is willing to support that price-it will hold until! Now, whatever you want to call us-those of us
who manage to get the better grip on that factor most
likely fare well depending on our situations.
OK, the price of the yellow stuff is descending. No News! Keep going as usual. Good news! If you want to unload a few bars, thats up to you. BUT, why do so on the down tick. As has been pointed out, like most everything else in life-business/politics...
ments proceed in cycles.
My question:
"You in this to make money or some other less functional medium?"
And frankly, I don't want to see gold trading at 5,000
per ounce-although I suspect it could. Reason being,
A VERY BAD SIGN FOR THE PLANET! While I probably
should not say it, so long as it were left in the hands
of a rational populace-I advise against allowing gold
to advance beyond 3,000.
Investing in gold is wasting our time and productivity. Society does not get anything and money has tied up without any return to the economy. If we invest in alternative investment with long term potential and productivity in the long run every body such investors, consumers will benefit and we will see strong economy through out the world.
Beyond that, you're really not talking about gold versus equities at all, you're talking about cash versus equities. So, should I invest in the S&P 500 at 20x earnings with earnings just starting to fall from historically high levels? Should I buy bonds when yields are below government inflation figures and short-term rates not far from zero? History says no, overweight cash. Real USD interest rates are negative, which suggests I should buy gold instead of dollars, especially after corrections. Prudent risk management suggests adding other commodities and currencies as well, and trimming my positions in these for specific undervalued equities on spike tops. If interest rates rise and/or equity valuations return to levels justified by their value creation and dividend payments, trade out of those positions and into debt and/or equity securities that meet your investment criteria.
It's really pretty simple, isn't it? Why all the emotion? Is it because many of you, like me, have real fear that the dollar, and with it dollar-denominated bonds and stocks in companies receiving all their revenues in dollars, will go to zero or otherwise suffer an enormous loss of value? That Americans' greed, stupidity, and arrogance will finally come home to roost? Well, good. I too like to believe people get what's coming to them. But that doesn't change the investment strategy, it just means the exit plan won't be needed. And it doesn't mean you shouldn't use that exit plan if the final collapse turns out to be arbitrarily far off in the future. This is basic value investing, and it should allow you to increase your wealth in all economic conditions. If you're a trader, well, what do you care? You're not concerned with value, only with price. Whether gold or anything else is a good investment is irrelevant, only whether it's a good trade. Nothing wrong with that, but in that case there's hardly anything here you'd care about.
Another problem with the methodology has to do the way average percentage yields are calculated. To walk through an example. Let's say that at the start of 2000 the Dow is trading at 10,000. In 2001 it closes unchanged at 10,000. Let's then say in 2002 it falls badly to 8,000, a 20% loss. Let's say finally that in 2003 it rebounds strongly to 12,000. Now think about the investor who bought in 2000. After 2 years he is looking at a loss of 2000 points, from 10,000 to 8,000. He is down 20% over 2 years. The average annual percentage loss is then simply the square root of -20% or about -9.5% per year. Now let's look at his more fortunate counterpart who bought the Dow not in 2000 but at 10,000 in 2001. Two years late in 2003 the dow is trading at 12,000 and he is up 20%. Annualized this is 9.5% per year gain. See where this is headed? Although we have all heard the Ibbotson study that says stocks return ON AVERAGE 7.2%/year only a few have pointed out the flawed methodology. IT makes a huge difference what year you start counting in. The way to fix this problem is create several model portfolios each starting in a different year and then continuing for say 50 years and then AVERAGING the returns. It so happens that Ibbotson started his study in 1900 the start of a long bull market. Had he started his study in 1929 that 7.2/year return would have dropped dramatically (I think the number may have been closer to 4%).