Todd E. Gray, Portfolio Manager
The glitter of gold has been the cause of heartbreak, murder, wars and obsession throughout recorded history. For much of human history gold has been synonymous for wealth and the “Golden Rule’ has been interpreted as he who has the most gold rules! The desire to own gold has been interwoven into cultures for thousands of years. Coins containing gold first appeared around 800 B.C., and the first pure gold coins were struck during the reign of King Croesus of Lydia approximately 300 years later. The tombs of many Kings and Pharaohs contained substantial amounts of gold that they believed would buy them favor with the Gods. Greek mythology touched upon the danger of manís love affair with gold through the story of King Midas. The obsession of humankind with gold is not just restricted to ancient history but also to more recent times as witnessed by the California Gold Rush, as well as the popularity of the reality show “Gold Rush” which follows modern day gold miners seeking fortune. Movies such as “The Treasure of the Sierra Madre”, “The Far Country” and more recently “The Italian Job” all focus on the effect that gold has on the character and morals of ordinary people.
The Gold Conundrum
Gold has been a divisive issue for the investment community with gold ìbugsî believing it to be the ultimate storehouse of value while stock aficionados view gold as just a pretty rock. Late-night television infomercials and radio advertisements pitch gold as the only hedge against a future where paper money and assets are worthless. Such claims tap into our fear that the end of life as we know it is fast approaching. It is tempting after listening to such dire forecasts to call the 800 number and start stocking up on gold coins or bars. Because of the constant promotion of gold as a panacea investment, we decided to address the issue in this newsletter. The goal of this article is not to make a case either for or against investing in gold, but to lay out the pros and cons of doing so.
Ultimate Storehouse of Value
Pros of Owning Gold
- Hedge against inflation
- Grows in value during times of financial crises
- Non-government currency
Gold has been pitched as a safe haven during times of high inflation, financial crises and geopolitical uncertainty. Over the past 50 years gold prices have generally risen and outperformed the stock market during periods of high-inflation. During the 1970s, when inflation increased at an annualized rate of 7.4%, gold prices increased at an annualized rate of 30.8% com-pared to the 1.6% annualized price return for the S&P 500 Index. However, during the period from 1975 – 2014, while the return on gold did outpace the rate of inflation by 0.8% annually, stock returns outpaced inflation by 8.3%.
Gold has often been called the “currency of fear” because people flee to its perceived safety when world tensions rise, or we experience a lack of faith in the financial markets. The best example of this was the recession and financial crisis of 2008. The price of gold jumped 131% from late 2007 to September of 2011, when it hit a high of $1,921 an ounce. This year we saw gold jump in price by over 10% in the week following the surprise Brexit vote.
There is an old saying that an ounce of gold will always buy you a good men’s suit. This is essentially the argument of diehard gold bugs who want to own gold because it is a non-government backed currency. Currently no country backs it currency with gold. For half a century beginning in 1879, Americans could trade $20.67 in cash for an ounce of physical gold. The U.S. dropped the gold standard in 1933 and in 1971 severed the link between gold and the dollar, meaning the dollar is no longer “as good as gold”. Throughout history, government issued currencies have all suffered from devaluation, often from poor financial practices, and the value of currency can be driven up and down by speculators through currency trading. The argument is that by owning physical gold, an individual has an asset that is a true storehouse of value that a paper currency can never be.
Just a Pretty Rock That Sits There & Looks at You
Cons of Buying Gold
- Produces no income
- Speculative, no underlying intrinsic value
Warren Buffett, CEO of Berkshire Hathaway, is one of the most famous stock investors of all time. He is also one of the most outspoken opponents of gold investing. In a letter to shareholders in 2011 he wrote that the monetary equivalent of all of the gold in existence could buy all of the farmland in the U.S., plus 16 Exxons. He goes on to say “A century from now, the 400 million acres of farm land will have produced staggering amounts of corn, wheat, cotton and other crops, and will continue to produce that valuable bounty. Exxon will probably have delivered trillions of dollars of dividends to its owners, and remember you own 16 Exxons. Meanwhile, the 170,000 tons of gold in existence at that time would be unchanged in size and still incapable of producing anything.”
While gold has a reputation for being a storehouse of value, like stocks, the price of gold can drop as quickly as it goes up. In the wake of the 1970’s oil cri-sis and high inflation, gold hit a record peak of $850 an ounce in 1980. It would be another 28 years until gold surpassed this level. After rising to $1,921 per ounce in 2011, gold prices dropped to $1,184 by the end of 2014.
Since gold produces no income, it is intrinsically worthless or priceless. Unlike stocks, which represent ownership of an actual business that generates a cash flow creating an intrinsic value, there is no way of calculating the actual value of gold. It is simply a matter of what buyers are willing to pay for it. Warren Buffett explains this well, saying “Gold is a way of trying to profit from fear and it has been a pretty good way of doing so from time to time. However, to profit, you have to hope people become more afraid in a year or two than they are now, or you will lose money because gold itself doesn’t produce anything.”
In summary, although gold is not a panacea for inflation, it has produced a return that exceeded the rate of inflation. History has also shown that gold has done well in response to unexpected crises, however, its returns relative to stocks during prolonged periods of troubles have been inconsistent. In an article by Jason Zweig titled “Let’s Get Real About Gold: It’s a Pet Rock,” he writes “Own gold if you feel you must, but admit honestly to yourself that you are relying on hope”. Here at Trust Company of Vermont we have not had a dedicated allocation to gold, instead investing in it on an individual basis to meet specific client concerns. We encourage clients that want to invest in gold to limit it to a small part of their total investments. To invest a substantial portion of your investable assets in gold is, as Zweig writes, “a leap in the dark that not even goldís glitter can change.”