Banks and stock brokerage houses like Citigroup (C), Morgan Stanley (MS), Goldman Sachs (GS) and JP Morgan Chase (JPM) are ready to join together, and chant the mantra of the Cult of Equities. They've got a lot of supporters in the field of economics and finance. The mantra is something like this, repeated over and over again:
Stocks are the best investment over time.
Most of these same folks also advise that "aggressive" investors, willing to take "risk" and buy "growth" stocks, which pay little or no dividends, earn the most over long periods of time. The same people also tend to advise that gold (GLD) (IAU) (PHYS) is a bad investment because it pays no interest and is "speculative."
First, gold DOES pay interest to those willing to take the risk of lending it out. There is an active market for lending gold. But, that is a story for another day. The story for today is putting the Cult of Equities to the test. Are stocks really the best investment over long periods of time?
A number of factors are involved. We should remember that past performance is no guarantee of future performance. But, for the sake of curiosity, we can potentially look at the performance of several different stock indexes like the DOW Industrial Average (DIA), the S&P 500 (SPY) and the NASDAQ (QQQ). Once we've done that, we can compare them with gold.
My first inclination was to look at the most recent decade. But, stock performance since year 2000 has been dismal. Equities certainly have NOT been a good investment since then. So, to be fair, I decided to look at a more substantial period of time. Furthermore, of the commonly known and used indexes, I decided to use the S&P 500. It is much broader than both the DOW and NASDAQ 100, and it has been around for 55 years.
If we take a quick glance at the performance of equities over the last 55 years, they look great. But, we must look deeper. Remember, the Fed and other central banks have a perpetual inflation policy. They have carefully nurtured ever-depreciating fiat currencies. Neither the U.S. dollar or any other currency has had a fixed value since 1933. A 1957 dollar is worth much more than a dollar in 2012. Comparing the simple value of the S&P 500 in 1957 to the value now, therefore, is like comparing apples and oranges.
In comparison to easily printable dollars, gold is a tangible item of limited quantity. Accordingly a "semi-fixed" value can be assigned to it, at least for purposes of doing our analysis. As soon as we move away from the depreciated fiat currencies, and begin to measure performance against the inflation resistant gold "money," stock performance declines markedly.
Standard and Poor's began publishing the S&P 500 index on March 4, 1957, at an approximate value of 45. At the same time, gold was selling on the free market, in Zurich, Switzerland, for about $35 per troy ounce. That was approximately the same price at which gold was traded between national treasuries. Since then, gold has risen to about $1,770 per troy ounce. That means that, since 1957, the U.S. dollar has retained slightly less than 2% of its value measured in gold ounces.
To avoid a loss of gold buying power, S&P 500 index fund investors need the index to rise to a bit less than 2,250. Unfortunately, it has never been that high. Yesterday, for example, the S&P 500 closed at 1,433, not far from its all-time highs, but less than 2/3rds of the way to 2,250. Over the last 55 years, in other words, S&P 500 investors have lost about 1/3rd of their capital in terms of gold.
It is true that we haven't added dividend income. We also haven't deducted taxes, commissions and fees, or the interest that can, theoretically, be gained from loaning out gold. Without that dividend yield, the S&P 500 investors would have lost big time. But stock investors do collect dividends. They also pay taxes. The current 15% dividend tax hasn't been around very long. They are a part of the Bush era tax cuts that may not survive the "fiscal" cliff coming on January 1, 2013.
During the 1960s and 70s, top tax rates ranged as high as 90%. As increasingly insolvent governments become increasingly desperate for cash, they may move closer to that range in the future. In addition to dividend taxation, changes in the stock index have forced S&P 500 investors to recognize capital gains. That is because such investors cannot simply keep stocks for 55 years. The index is always changing. Stocks are moved in and moved out.
Investors must buy and sell stocks almost every year just to keep up with changes in the referenced index and weightings. Whenever this happens, they must recognize capital gain. They must also pay commissions and fees. While the cost of trading is now cheap, in the old days, brokerage commissions could range as high as 3% for a round trip buy and sell.
To make matters worse, because of central bank inflation policy, many of the capital gains upon which taxes must be paid, actually result from nominal, rather than real appreciation. That means stock investors are regularly paying taxes on inflation, rather than an increase in the real value of their holdings. In contrast, gold investors can simply keep gold in a vault forever. When they die, the gold becomes the property of the heirs, and it is assigned a stepped up tax basis. Their "cost" is whatever the gold is worth at the time of death.
Right now, stocks sit on a precipice. They have soared since 2009, primarily because of the massive monetary debasement since then. But, a huge generational bubble is about to burst. No amount of money printing will change this fundamental. The baby boom generation is retiring. Those retirees will need to liquidate investments. We have seen some of that. Hundreds of billions have been pulled from stock funds over the last year. Even so, about 99% of all retiree assets (other than the houses they live in) is invested in financial assets like stocks and bonds. Retirees don't generate earned income, and cannot substantially increase stock and bond holdings. In contrast, 401K retirement plans contain almost no gold at all so the liquidation is unlikely to affect gold prices.
How an S&P 500 investor performed since 1957 would largely be determined by his tax bracket in the intervening years. But, looked at broadly, stock investors stand about even with gold investors, so long as we add back the dividend income, deduct the commissions and fees and discount the fact that taxes had to be paid on nominal but fake capital gains. But, in order to attract investment, given that the chance of loss is great whenever money (in this case, gold) is put at risk, stocks need to have performed much better than gold in order to justify investing in them. That simply has not been the case, and the trend of the last decade implies that things will get much worse for equities.
The "wonders" of stock investing don't hold up under the microscope. Although fiat money can be manufactured out of thin air, value cannot be. Society's capacity to produce depends on people. The amount of gold, taken from the ground, has approximately kept pace with the population. So, it does makes sense that gold and stocks would perform approximately equal over long periods of time, which has been the case. Going forward, however, western society's age demographics are highly unfavorable to further stock price appreciation except from monetary inflation.
So, what is the better investment? Gold or the S&P 500 stocks? With respect to the past, that depends partly on your tax bracket, and partly on what you want the money for. If you intend to pass a legacy on to your children, gold appears to be the better investment. If you want to consume part of your capital during your lifetime, however, historically, the S&P 500 would have been a slightly better bet. Remember, though, past performance is no guaranty of future performance. Going forward, S&P 500 investors are facing a western world in severe demographic decline and unsustainable government and private debt. Gold is likely to perform much better than a broad stock index during the next decade, at least.