Jeffrey A. Miller

Does Gold Beat the DJIA? It Depends

DJIA vs. Gold Gold as a store of value March 19, 2009

I appreciate all the comments on my article. Those who think me an “idiot” will not be surprised to learn that my wife agrees with them at least once a week. In an effort to diminish that view I have done a bit more research to compare gold with the CPI (consumer price index) as published by the Bureau of Labor Statistics. The CPI is available from 1913 to the present. I selected, again, the annual values to compare with the annual spot price of gold. Several comments suggested gold is an insurance policy against inflation I presume. Others suggested gold is a “store of value” (SOV) not an investment, again I presume against the loss of value due to inflation. At least one excoriated me for ignoring the fact that ownership of gold was prohibited until 1974.

The comment about gold ownership being prohibited until 1974 ignored the main thrust of the article. Gold completely failed as an investment over the twenty year period from 1980 through 2000. Yet gold was freely traded during this time. I examined the longest possible historical record to obtain as much information as possible about the relative value of gold versus the DJIA. Yes, gold was prohibited until 1974. But ownership of stocks was relegated to a small minority of the population as well. Neither fact changes the conclusion of the article that whether gold outperforms the DJIA depends on the current economic circumstances. Neither is “best” at all times.

As insurance against inflation I believe gold also fails since insurance is designed to replace value dollar for dollar. If 10% of a portfolio is in gold then a doubling of the value of gold is required to increase the portfolio by 10%. Stated differently, to protect against a 10% inflation rate requires that gold (at 10% of the portfolio) double in price. Gold certainly can double in a year (or less) but it has never done so over any extended period of time and never done so during periods of low to moderate inflation. Gold only jumps in value during periods of extreme financial stress. Of course, today we are in fact experiencing extreme financial stress so gold is doing well. For now.

As a store of value (SOV) gold, or any asset for that matter, must also perform well as an investment. I am clearly not the brightest bulb in the chandelier but I cannot understand how a poorly performing investment can succeed as a store of value. But set that argument aside. Given a historical record of the CPI how does gold stack up as a store of value? The BLS statistics set 1982-1984 as 100 and then adjust the CPI up or down accordingly. Thus if inflation at some future time is double what it was in 1982-1984 the CPI goes to 200. If it were half the CPI drops to 50.

Since the 1983 CPI is set at 99.6 I arbitrarily used that as my base level for inflation. Also, since gold had been trading freely at that time I set the yearend spot price of gold, 415.00 as my base level for the price of gold. Using the base level of gold I then adjusted the price using the annual CPI figures for each year. By coincidence the CPI adjusted price of gold in 1974 was 203.78 versus the actual spot price of 195.20 which is extremely close.

There were several interesting results from this exercise. First, the CPI adjusted price of gold was well above the government set levels from 1913 through 1973, sometimes by 2 or 3 times. This suggests the government was arbitrarily devaluing the dollar, in gold terms during this period. No big surprise there. What was a surprise is that from 1974 through 1978 spot gold was still below the CPI adjusted level. However, even more stunning is that the only times spot gold exceeded the CPI adjusted level was from 1979-1983 plus 1987 and 2008. If we only look at the period from 1974 through 2008, when gold was freely traded its SOV function was only reliable for a single 5 year period plus two additional separate years of extreme financial stress. Obviously 2009 and beyond may add to gold’s SOV utility.

My conclusion is that gold as a store of value, as a hedge against inflation and as an investment is only valuable during periods of extreme financial stress. We are in such a period at the present. Gold is doing well, at the present. Stay alert for improvements in the underlying economic circumstances and protect yourself. The gold versus CPI table is available at redst8r.wordpress.com

A Five Year Investment Plan

GRAR: Thank you for your comment. You had good points on all counts. Your points in order:
1) It does take a considerable amount of time to oversee the investment. I do question whether our stock investments shouldn't also be monitored closely. But I appreciate the distinction. To some degree this is a matter of preference - oversee a major stock investment or a small business.
2) Here I do disagree. Yes, it is unlikely GE will go to zero. But it seems quite possible that Citi or BofA or GM etc. may in fact go to zero. My small business also has the risk of going to zero although it is not "the most likely outcome". In fact the worst outcome (which you also mentioned) is not going to zero but slowly bleeding to death. Again, I have cutoff points (e.g., stop-loss) established for just that reason.
3) My requirement all along was to be the majority owner for exactly the reasons you state. I do not participate in the daily operations but by retaining majority ownership I can pull the plug - and will - when and if it becomes necessary. Managing this risk is very similar to managing my risk in a major stock investment where timely information is often difficult to obtain and may only be unearthed after the fact.

I'm sure we all agree there is no risk free investment so it does become a personal choice. The liquidity argument is the strongest against a small business. Being in that position now brings that fact home. But it is not necessarily a sufficient reason to avoid investing in a small business. Thanks again, I appreciate all the thoughtful comments.




On Feb 19 02:52 PM GRAR wrote:

> Investing in small business is a fine idea. I see only three problems.
>
>
> First, investing in small businesses requires a serious investment
> of time, both in finding the most promising among the thousands of
> opportunities, and keeping close tabs on the progress. This sounds
> more like a second job than an investment.
>
> The second problem is risk. It is true GE stock could go down 30%
> from here. But it is very unlikely to go to zero, which is the most
> likely outcome for the majority of small businesses.
>
> The third problem is liquidity. If GE goes down 10% you can always
> just sell the stock. With a small business, you are pretty much locked
> into the investment. The only way out is to liquidate or sell the
> entire business. And even with your increased "say", unless you own
> a controlling majority, you don't get to decide when to pull the
> plug. You could be treated to watching your equity slowly bleed away.
>
>
> To summarize: I agree that the stock market probably will not appreciate
> in the forseeable future, and that small business is potentially
> more profitable. However, direct investment in small ventures ("angel
> investing") entails more downside than was described.

A Five Year Investment Plan

Thanks for your comment. I agree that a strong currency will offset global inflation pressures. I believe currency values are relative such that even if our domestic economy is in the tank, our currency can be strong if we are the best economy of a bunch of bad economy. The best of the worst so to speak.


On Feb 19 10:18 AM kelm wrote:

> This is a great article because you analyze the problem, draw your
> conclusions and then state exactly what you plan to do to implement
> those conclusions - bravo!
>
> I completely agree with your conclusion that the US equity markets
> are impaired and will be for some time to come. Te day traders I
> talk to are having fits with this market as well so I don't even
> think it is a good traders market.
>
> Keep in mind that for much of the 1990s and 2000s the US imported
> deflation and were happy to do so due to our strong currency. The
> dollar, despite recent strength, is well below the levels it was
> at previously. The next big round of inflation will be partially
> imported and partially home grown, and the currency may be a lot
> lower.
>
>

A Five Year Investment Plan

Thanks for your comment. I too looked at dividend stocks but was dismayed that those paying higher amounts (4%+) were either cutting or likely to cut their dividends. Those paying a reasonable amount (2% - 3%) sadly just didn't provide enough income to justify the risk. I am open to quality recommendations though. Dividend stocks will be one of the best equity investments for the next 5 years.


On Feb 18 05:38 PM Larry House wrote:

> I think your note of caution is well taken. I see nothing wrong with
> bonds for the next few years. I am not opposed to holding a few good
> dividend-paying stocks, but my expectations for them are quite modest.