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All That Glitters

I enjoy the copy of some of the advertising promoting gold:
“in 1920 a man could buy a suit with a $20 bill or $20 gold coin. But in 2006, $20 won’t buy a shirt, and a gold coin, now worth over $500 will buy a suit.”

So what? At 12% (the S&P return during this time according to the MoneyChimp) , your money will double every 6 years. Over 86 years, that’s more than 14 doublings, or over 17,000 times your investment, $340,000 for your $20 bill.

Someone tell me how an ad can make an ‘investment’ that will grow from $20 to $500 in 86 years, an annual return of 3.8%, look good when the alternative (the S&P) would return 680X as much.

From the 1980 peak, gold would have to exceed $4800 to outperform stocks over the same period. I look at the 35 year chart:

and I’m no technician, but ‘down’ looks far more likely than up. Within my market timing article, I discuss how buy and hold will profit if you are patient. Even buying at the market high reached in August of 1987, right before the crash would be profitable if you held long term, returning nearly 8%/yr up to the market bottom of 2003. Now, if you bought gold at $850, in 1980, and were patient, reinvesting dividends* along the way, by now, er, nearly 28 years later, you’d still be short of breaking even.

(*Gold offers no dividend of course. How could it?)


  • eric October 11, 2007, 11:44 am

    I find your analysis of gold price missing some key details. Sure, the “market” has outperformed gold over the last 86 years. But this is not a valid comparison. The dollar and gold were fixed at $35/oz until 1971.

    Taking the 35 year period in your chart, it is easy to see the market has outperformed gold. Looking at it another way, on a relative basis, the Dow is very expensive in terms of gold. As is oil, the median-priced home, etc.

    What this tells me is not that gold is worthless, but that paper assets and assets that are prone to the effects of monetary inflation, are exhibiting the symptoms said monetary inflation. If an item can be bought and traded with leverage (usu. including other peoples money), then that item is susceptible to price inflation via monetary inflation. You see, as new money is created, it gets distributed unevenly. Stocks are inflating faster than the money supply simply because that’s where the new money is being concentrated.

    So is it likely that newly created money will continue to concentrate in equities? Simply stated, no, I don’t think so.

    Corporate earnings are peaking. Walmart, Target, Lowes, Home Depot have all warned of a consumer-led recession. Consumer spending is pulling back, whether by choice or by necessity. That’s 70% of GDP.

    And remember that recent corporate EPS have been goosed not by productivity, but by financial trickery like secutitization of receivables and debt issuance to fund share- buybacks.

    So I argue, both on an inflation-adjusted basis and as a counter-cyclical hedge on a relative basis, gold looks cheap here. Is it more likely that the equity markets continue rising in the face of falling sales? Or will there be a flight from “risky” stocks into things that are more secure, more real?

    To me, this is the point in the cycle where one looks to lose the least, not make the most.

  • JOE October 11, 2007, 5:43 pm

    I appreciate your taking the time to write, and you do bring some other insight, a welcome different view. I didn’t choose the timeline for the suit comparison, the company promoting gold used that analogy. That aside, you may be right, there is always the chance that a given asset class will outperform others. But, I’d still ask, what is the compelling reason to assume that gold will outperform long term? If you are anti-dollar, and anti-stock, I’d suggest a foreign bond fund, so you could get some return (interest) on your investment.
    Again, your view is welcome. Thank-you for writing.

  • eric October 12, 2007, 1:42 pm

    Thank you for responding. I do in fact own foreign bond funds as a mechanism to diversify out of dollars.

    However, there is one risk that foreign bonds and currencies cannot divest from. That is the perpetual and painful tax of monetary inflation, aka, currency devaluation.

    Simply stated, physical assets (commodities, real estate) offer protection from monetary inflation. And monetary inflation is the policy of choice for all central banks.

    Owning any currency (or bond in that currency) only makes sense if its interest rate minus the rate of its currency’s devaluation exceeds other investments in similar currencies.

    In the US, for example, a 3 month note will provide somewhere around 4.5%. But what is the rate of devaluation of the dollar through monetary inflation? If it exceeds 4.5%, then gold pays a better dividend vs. the treasury, no?

    I wouldn’t classify myself as a goldbug or anti-dollar. I view investments in gold and commodities as smartly diversifying into assets that are uncorrellated with stocks and bonds.

    Please see research by Ibbotson :


  • JOE October 13, 2007, 4:21 pm

    I always try to keep an open mind, and toward that end, I read much of the article for which you posted the link. It’s certainly worth reading, as it provides a convincing case for the use of commodities in a diversified portfolio. The analysis makes use of a commodity index in which precious metals compose 2.35%, industrial metals, 7.54% (one can read the full study to see the rest), and concludes that a good portion of excess return comes from an anomaly related to the difference in spot and futures pricing from when the contract opens till when the contracts expire. Nowhere is a buy and hold suggested for any one component.

  • eric October 15, 2007, 10:02 pm

    I tend to disagree. Ibbotson comes to the conclusion that including an annually-rebalanced, fully-collateralized index of commodity futures in the opportunity set of investable assets benefits a buy-and-hold Modern Portfolio Theory (MPT) strategy.

    Remember, it is not just returns that count in MPT, but volatility/risk. Finding asset classes with low covariance is the cornerstone to accomplishing that feat.

    Departing from commodities and returning to gold, Ibbotson has another paper analyzing the role that gold, silver and platinum can play. Their conclusion: due to the negative correlation of PM relative to stocks and bods, for an aggressive investors using MPT, as much as 12.5% if the portfolio could be in PM.

    I’m sorry I can’t find a link to the entire paper, I can only find a summary:


    I suspect that you and I have a very similar investing strategy, except that I allow more assets into the “opportunity set,” and I am willing to take the risk that the next 35 years will not be anything like the preceding 35 years.

  • JOE October 16, 2007, 6:09 pm

    Eric – I’m happy to continue the dialog even if it’s just us. What did you disagree with in my last post? The report you linked to was convincing, but there were some key points, among them that annual rebalancing was key to the ‘stock-like’ returns. We agree there. And given the compelling story within that article, I’d still point out the failure of buy and hold of any one component. Buy and hold on gold is no better over time than holding cash, but I concede that the commodity mix and annual balancing will sell the components (or a portion, to be specific) that are overpriced, and buy the underpriced ones. I see how that may work for even non-income producing assets. Again, thanks for your intelligent posts. Too much spam lately.

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