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

Deflation Risk Dipping As Stagflation Risk Rises

Credit contraction is creating in asset devaluation. This combination in turn results in a contraction in net demand and employment not deflation. I don't buy the deflation scenario. Deflation, like its sibling inflation, is a monetary phenomenon. Technically we can't have inflation and deflation at the same time. What we might actually have at the moment is more consistent with a stable price system than either of the "...flation" siblings. That is, in a stable pricing environment some prices may rise but others will fall.

I also don't buy into gold as a useful investment but if the crowd wants gold (or tulips or oil or houses) the price will rise. Just please go to goldprice.org and check the 30 year history of gold prices. It will streak higher in financial panices (early 80's and today) but otherwise is in a trading range. And if the world's central banks decided to unload their hoards? What then?

I am concerned at the future prospect for inflation as the Fed monetizes the bailout(s). But since the Obama administration, like the last days of the Bush administraion, is following the Japanese economic program we can expect multiple failed bailouts and a long, long time before inflation rears its very ugly head. I'll be watching the markets, considering TBT at some point, and who knows, maybe a bit o' the gold. (Actually diamonds are better. Smaller, lighter, easier to carry and also valuable. Plus the diamond hoards are held by private companies.)

Deflation Risk Dipping As Stagflation Risk Rises

I agree with jkca1. Our markets in NC are quite full thanks. Prices aren't rising nor falling much but there are more sales (2 for 1 for instance).


On Jan 26 05:43 PM jkca1 wrote:

> I don't know where CAFK lives but our supermarkets in CA are well
> stocked and full. You name it, it's available and plentiful.