ABG

Gold: Not an Effective Hedge Against Inflation

The author arbitrarily uses 1980, at the top of the 1980s market cycle, to support the idea that gold is a bad hedge against inflation. But, we are near the bottom of the gold cycle right now, not the top. The last 8 years of gold's appreciation happened in a time of deep calm and steady economic growth. It was not the result of fear and panic, as in the 1970s. The first year of panic was the second half of 2007 to 2008. So, the gold cycle is now just beginning, not ending.

Arbitrary choice of 1970, at the bottom of the 1970s gold cycle, as a date upon which to base an analysis will give a completely different picture, compared to the choice of 1980. The price for gold on the Swiss market was $42 per ounce. If you had bought gold in 1970, keeping it stored in Switzerland (because Americans were not allowed to own bullion until 1974), you would have had incredible gains to date, exceeding the official measures of inflation.

Of course, there would have been yearly storage charges, but, if you owned the S&P 500 index, you would have needed to pay taxes on the dividends, and on all the sales that you are constantly forced to make when various stocks are removed from the indexes. If you owned a passive mutual fund, you would have been more seriously impacted by taxes.

If the index creators just left all stocks on the index that started on the index, and never got rid of the dogs, your gains in stock investing would be non-existent. So, companies are always added, and removed, and funds that follow the indexes, or you, need to buy/sell in sympathy with these moves to keep your portfolio consistent with the index. This creates taxable events, and taxes reduce return. In comparison, gold is not taxable until it is sold. Most people never sell it, so the capital gain is never taxed.

At any rate, after taxes, you would have had a much bigger gain from a static gold investment, dated from 1970, than from investing the same amount of money in the S&P 500 in 1970.

That is not to say investing in the stock market is a bad idea. It is simply a bad idea at this moment in time. There will come a time for stock investing, but not is not that time. Right now, smart people will opt for gold. Even though the stock market will go up a lot in the next few years, from current depressed prices, all of these gains will be for show only. They will likely be merely nominal gains, even though I do think we will be seeing DOW 30,000 by 2011.

Because of the circumstances that surround us, over the next 5-10 years, stocks will arise primarily out of inflationary pressure created by the Fed in its quantitative easing program. In other words, after adjustment for the reduced buying power of the dollar, stock gains will be non-existent, at least for many years. Gold, in contrast, will probably go up in real terms, because of the increased levels of world instability, a continuing decrease in mine production in spite of higher prices, and simply that almost everyone wants at least a little bit of it (whether in bullion or jewelry) and the world population is growing much faster than the world's stockpile of gold.