Gold as an Investment

[Rhea]

This topic has come up from time to time, and one question that is often raised is, "what good is gold as an investment against currency devaluation?". My personal theory is that since gold can't be "printed" then people will continue to use something that they feel can represent value without governmental manipulation. Others have claimed that it is "just metal and not a terribly useful one, at that, nowadays".

This is strictly curiosity for me, because I'm not an expert, so I'm seeking discussion here to see how the arguments can be supported or refuted.

"Where's the Gold?" (http://www.financialsense.com/editorials/salinasprice/2007/0529.html)

I saw this article today and wondered, does it suggest that the value of gold as a "currency" has validity merely in the number of people who think alike? Or does it suggest that of course individuals are buying it up, since it's for sale. But if they didn't value it as investment, what would happen to it if Central Banks were selling but no one was buying?


Made me wonder. Your thoughts?

[Loren Pechtel]

I remember something like 20 years ago when gold was even higher than it it now.

[I. C. Unicorns]

People can argue the merits of gold as an investment till they are blue in the face, and they do. However, history shows it to be a piss poor way to increase wealth.

[Axulus]

The real gold out there are the companies that are constantly innovating to improve our lives by constantly trying to come up with new ways to make their product or service better or cheaper or coming up with a new product or service all together. That is the investment that will really pay off, not a lump of gold.

[laughing dog]

The market value (sale price) of any item depends on the demand (willingness to pay) of the users and the supply of it. If the public viewed gold as valuable as mica, it would fetch roughly the same price.

Historically, people have valued gold more highly than most other metals, so it has typically commanded a higher price. However, if the all Central banks attempted to sell their gold reserves, the market supply of gold would increase. Typically that reduces the market price. If the increased supply is large enough (or demand is relatively price insensitive), then the market price could drop quite a bit.

[Hooboy !!]

It is not as if gold does not have utility. Jewelry is a significant consumer of gold and people wear a lot of it. Aside from its industrial applications. The thing about gold though is its historical appeal. It is just one of those things that will not go out of fashion, unlike muscle cars or other types of investments of that type.

It is hard to say why it is appealing. It could be because it does not rust or otherwise degrade over time. Maybe because it is shiny. Maybe because it is easy to work with and produce some really lovely things. Maybe because it is portable. I don't know. Personally, I own almost no gold at all. Not even jewelry.

[LuisGarcia]

This topic has come up from time to time, and one question that is often raised is, "what good is gold as an investment against currency devaluation?".


Well, I'm still new here, so apologies if I either come across as a dummy or repeat what's been said before.


My personal theory is that since gold can't be "printed" then people will continue to use something that they feel can represent value without governmental manipulation.

Correct. Gold is one of the few assets that must retain it's value.It's in relatively short supply, it doesn't tarnish, it doesn't get used (much) in any industrial process etc etc. In other words, it will always have a very stable value. It is therefore a good store of wealth.


Others have claimed that it is "just metal and not a terribly useful one, at that, nowadays".

Also correct. The fact that it is not "useful", though, shouldn't worry you. Suppose, for example, someone finds some magical way of replacing all the copper that's used in industry tomorrow with water. Copper prices would collapse overnight. That's not going to happen with gold. Hence golds stability.



I saw this article today and wondered, does it suggest that the value of gold as a "currency" has validity merely in the number of people who think alike?


Yes, in a way. But so does everything. Anything that no one wants to buy will have a rock bottom or no price. Gold is not special in that sense.


But if they didn't value it as investment, what would happen to it if Central Banks were selling but no one was buying?


It's price would collapse.

The thing with gold is it's a store of wealth. Suppose you're fairly well off. What could you buy in order to leave wealth to your great great grandchildren? What can you buy that you can guaruntee will not go bankrupt in the next 100 years?

Not much. Except gold.

It doesn't pay dividends to hold gold, though, so those trying to attain wealth via the long, boring but royal road of compounding over time don't like it. In a deflationary environment, such as the western world has been enjoying for nearly 30 years, golds price will grind down. In an inflationary environment, though, it will grind up. I.e. it's preserving your wealth against the forces of fiat printing.

Everyone who has posted so far (that I can tell where they are) is US based. I'm not. If you can, it might be illuminating for you to get hold of charts of gold priced in other currencies than USD, and compare them with what you've seen. Until about a year ago, gold was not in a bull market in almost any other currency than USD. Which should answer your question... it's an inflation hedge.

[mac_philo]

Gold is not a good investment. It is a valuable commodity which can be a hedge against inflation. That does not mean it is an investment or that typical individuals should buy gold. Professional traders might have reason to hold precious metals but I don't see any good reason for an individual long-term investor to do so.

Investments are things that have a positive expected return. The expected return of gold is zero. Unless you are living under conditions of extreme instability, I cannot see why you would want to hold gold. (If you are fleeing genocide or the like, obviously it is very valuable and useful.) You can hedge inflation using instruments that have positive expected return.

When you find that your investment strategy agrees with the apocalyptic Christian survivalist set, it's time to consider whether you have made an error. :)

[Loren Pechtel]

Correct. Gold is one of the few assets that must retain it's value.It's in relatively short supply, it doesn't tarnish, it doesn't get used (much) in any industrial process etc etc. In other words, it will always have a very stable value. It is therefore a good store of wealth.

Except it's value is affected by two important things:

1) Gold strikes.

2) How many people feel the need of gold as an investment.

Factor #2 is why the price goes up and down. When the economy is going down people get scared and buy gold. When it's improving they realize gold is a bad investment and sell it. Thus we see considerable swings in the price of gold.

Factor #1 isn't normally a big factor these days. Someday it will happen, though. Consider: I know of a location that probably has very high purity gold ore--perhaps even large masses of pure metal. There's no real claim of ownership, either. It's *VERY* deep and *VERY* inhospitable but someday advancing technology will make it worth it to go for it. What happens to your gold-based economy then???

[LuisGarcia]

If you're a professional trader, it's great. If you need to hedge against inflation, it's great. Otherwise, no. Thus far I agree with you, mac philo. This, however, just confuses me....

When you find that your investment strategy agrees with the apocalyptic Christian survivalist set, it's time to consider whether you have made an error.

How is taking a long term financial horizon equivalent to a non evidence based apocalyptic I'm-better-than-you-and-you're-all-going-to-burn weirdo-ness?

[LuisGarcia]

Except it's value is affected by two important things:

1) Gold strikes.

2) How many people feel the need of gold as an investment.

Factor #2 is why the price goes up and down. When the economy is going down people get scared and buy gold. When it's improving they realize gold is a bad investment and sell it. Thus we see considerable swings in the price of gold.

Factor #1 isn't normally a big factor these days. Someday it will happen, though. Consider: I know of a location that probably has very high purity gold ore--perhaps even large masses of pure metal. There's no real claim of ownership, either. It's *VERY* deep and *VERY* inhospitable but someday advancing technology will make it worth it to go for it. What happens to your gold-based economy then???

Erm, firstly, I'm not advocating a gold based economy, just gold as an inflation hedge. Secondly, "swings" in gold price happen because of strikes by miners, yes, but long term averages are driven by inflation rather than short term politics. Agreed. Traders can take advantage of short term swings, investors can't. Choose your horizon, then choose your strategy, then choose your instrument. Finally, the price rising to the point where your store of gold becomes economical to mine is known as capitalism. When technology advances to the point that it becomes worth mining, the price of gold will adjust for that.

(I'm slightly waffling in that last point as I'm afraid my tiny brain doesn't really see what your point was)

[mac_philo]

How is taking a long term financial horizon equivalent to a non evidence based apocalyptic I'm-better-than-you-and-you're-all-going-to-burn weirdo-ness?

My "you" was not directed at you. I was making the general point that if one's investment rationale agrees with theirs, that is a sign that one ought to think twice.

The survivalist kooks do not have a non-evidence based belief about gold. They use the same evidence that all gold-bugs use.

I do not think taking a long term financial horizon speaks in favor of gold. If you are worried about the future of currency, wouldn't you be worried about your own lifetime? It seems to me that any long-term argument in favor of gold is an even greater argument for storing food, water, and ammunition.

I think if your great-great granchildren did a cost-benefit analysis of storing gold for four generations vs. equity investments compounded for four generations they would much prefer you avoid the gold. That's factoring in the risk of socio-economic collapse and the national currency losing all value, in which case the gold probably would not make it to them anyway.

[LuisGarcia]

My "you" was not directed at you. I was making the general point that if one's investment rationale agrees with theirs, that is a sign that one ought to think twice.

The survivalist kooks do not have a non-evidence based belief about gold. They use the same evidence that all gold-bugs use.

I do not think taking a long term financial horizon speaks in favor of gold. If you are worried about the future of currency, wouldn't you be worried about your own lifetime? It seems to me that any long-term argument in favor of gold is an even greater argument for storing food, water, and ammunition.

I think if your great-great granchildren did a cost-benefit analysis of storing gold for four generations vs. equity investments compounded for four generations they would much prefer you avoid the gold. That's factoring in the risk of socio-economic collapse and everything, in which case the gold probably would not make it to them anyway.

Not really. By way of reply I ask you to go back 4 generations, and see what instruments were availble for you to invest in then. Now how many of them survive? I think you are confusing total civilisation collapse with the end of American economic hegemony.

The world has not ended in the last 4 generations. But, if your great great grandfather / mother was wealthy, and could have chosen one instrument to put their money in so that it would reach you intact with no further trading from anyone, what would your advice to them have been, had you been able to give it to them?

[mac_philo]

Four generations back we had a much more primitive economy, so many of the instruments and strategies available now would not have been available then. There were no mutual funds, much less passive index funds.

My first advice would be for them to again emigrate to America so I could still get my winning ticket in the uterine lottery.

My specific investment advice would be to have them create a trust to invest in 40-50 domestic stocks, reinvest the dividends every year into a random assortment of the highest capitalization stocks that were initially listed within the last twenty years (to nearly vanish the possibility of all stock holdings disappearing), with no trading. However I plead ignorance as to the exact nature of the stock market four generations ago. I do know the market now, and choose it over gold in this scenario. If I wanted to provide for four-generations hence I would create a trust to invest in a market-cap weighted global stock index.

What will be the case four generations from now is anyone's guess.

However, none of this seems practical, since the odds of any of us succeeding in getting assets to our great-great grandchildren are astronomically bad. This is in the realm of inapplicable theory IMO. At some point in the future, it will probably be the case that the US dollar doesn't exist and gold still has value. This has no practical application at this point in time.

[LuisGarcia]

Then I think we agree. If your horizon is intergenerational, then What will be the case four generations from now is anyone's guess.

and At some point in the future, it will probably be the case that the US dollar doesn't exist and gold still has value.

Is pretty much what I'm saying.

I plead ignorance as to the exact nature of the stock market four generations ago.
Here's a tip, almost nothing that was around then is around now, and I virtually guaruntee that you wouldn't have been able to pick, then, what would be, now. The point is simply that gold, for thousands of years now, has been the only reliable way to transfer wealth intergenerationally. All fiat currencies, let alone all companies, come and go. All fund managers, passive or active, come and go. If your horizon is long enough, there's no substitute for gold. Over any shorter horizon, there are innumerable better instruments.

[mac_philo]

Well then it sounds like we agree about a lot, but I think these points have no practical application, and I don't know if we agree about that.

It makes no difference if a passive fund manager disappears, or even if the entire firm disappears. You could set up a trust that would invest in the entire global equities market, capitalization weighted. If they invest through a firm which goes bankrupt, they do not lose ownership of the equities, they simply transfer them to another firm. I'll take that over gold. The initial underlying equities could ALL disappear over four generations, that does not harm this portfolio.

You can object that the trustee could disappear, but that's the same as me saying your mechanism for transferring ownership of the gold could fail.

It is true that gold has been the best massively intergenerational store of wealth. But that does not at all mean it is a vehicle for the INTENTIONAL and specific massively-intergenerational transfer of wealth. That the gold will have value in four generations, or 1,000 years, is totally orthogonal to whether you can dictate who will own it in four generations. If conditions are such that my global equities trust loses all value, I have no confidence in your mechanism for succesfully transferring ownership of the gold across four generations.

So I think that, in fact, nobody has the horizon you're talking about, and if they did, the fact that gold will retain its value doesn't get the job done. Individual stocks will disappear, but the total extinction of stock markets within four generations (which is the only thing that could harm a global index trust in the relavent sense) is no more likely than gold losing its value.

[LuisGarcia]

Well then it sounds like we agree about a lot,

always good to hear :)

but I think these points have no practical application,


I disagree. I think that for a relatively well off, financially educated westerner, you're probably right. For your average Chinese villager, I don't think you are.


and I don't know if we agree about that.
as above.


It makes no difference if a passive fund manager disappears, or even if the entire firm disappears. You could set up a trust that would invest in the entire global equities market, capitalization weighted. I'll take that over gold. The initial underlying equities could ALL disappear over four generations, that does not harm this portfolio.

Agreed. In a way. Intergenerationally, the price rises on the market are simply inflationary. The benefit comes from reinvesting dividends. BUT those benefits, long term, are offset by management fees.

The thing I'm trying to convey is that as a means to get wealthy, gold's not great. As a means to preserve wealth, it is.


So I think that, in fact, nobody has the horizon you're talking about, and if they did, the fact that gold will retain its value doesn't get the job done.

That is where you and I disagree. I know people with that kind of horizon, and, historically, gold is the only thing that gets that job done.

[mac_philo]

Chinese are not allowed to invest outside of China. I am indeed talking about westerners. Chinese do not even have the option of legally enacting my strategy.

I am talking about someone living in a free, western style democracy with an investor-friendly legal system.

If the people you know who choose gold live in a western, investor-friendly nation, then I think they're nuts to do more than a small percentage of their assets in gold. If these people are in a nation where enacting my plan is impossible due to legal, economic, and banking restrictions, then yes, they are doing the right thing.

If we are talking about someone with so much wealth that there is no need to increase their holdings even across four generations of inflation, then fine, they can build a vault under their private mountain. But I think that's a peculiar case.

[LuisGarcia]

So, what you're saying is, as an inflation hedge for (non professional trader) westerners, it's great, and as an intergenerational wealth transfer for non westerners, it's great, otherwise, there are better instruments out there?

[mac_philo]

No, I don't think gold is great as an inflation hedge for non-professional-trader westerners, I think it is usually folly. I'm going to talk about America because that's what I know. An American investor would be better off hedging inflation by having a meaningful allocation to foreign equities and inflation-indexed bonds like TIPS (US Treasury inflation protected securities).

For passing wealth down within investor-unfriendly nations, gold could be logical. I lump this into my initial "instability" clause. Investor-unfriendly nations are unstable, even if it sometimes takes awhile for that to manifest. ;)

[LuisGarcia]

No, I don't think gold is great as an inflation hedge for non-professional-trader westerners, I think it is usually folly.

Why?


I'm going to talk about America because that's what I know.
fair enough


An American investor would be better off hedging inflation by having a meaningful allocation to foreign equities
Where?

Let me clarify. Being a non US resident, a non US investor and a non US earner, I don't see the same inflation rate as you. And I don't see the same inflation rate as China, or India, or Brazil, or Argentina, or Russia, either. In my local currency I've seen a relatively recent breakout in gold. In USD that breakout has been going on for some time. That should be telling you something about our relative inflation rates. If you don't think gold is a good hedge against US inflation, then I would suggest you are too USD centric, and could do with seeing how gold has performed over recent years against other currencys. As I suggested earlier.

[mac_philo]

I am not US centric in my investing at all, so I find that sort of funny!

I never said gold isn't a good hedge, I said it isn't great. It isn't in my opinion required or recommended, when you have superior alternatives. I'm not going to invest in something because it is "good", I'm going to structure my portfolio to be the best. I don't invest in anything that has a zero expected return, even if it is for hedging. I can get that with positive return. So I think it's folly for an American to think they need gold as a hedge.

As to "where", I say, EVERYWHERE. It is dirt cheap, for Americans anyway, to invest in the entire global market. Here is an example (https://flagship.vanguard.com/VGApp/hnw/FundsHoldings?FundId=0991&FundIntExt=INT). You can also slice and dice into funds to get more small-cap or value or whatever, but I believe in keeping it simple.

[LuisGarcia]

Point taken.

So our difference boils down to whether gold is a "good" or a "great" hedge against inflation?

[mac_philo]

I'm lukewarm on whether it is a good hedge in general.

I'm opposed to the idea that Americans should use it as a hedge given the alternatives available to us. For one thing, they have much better expected returns with the alternatives. For another, more psychological reason, they use this hedging rationale to justify buying gold when it's hot, like right now. (I'm not at all saying you're swept up in gold fever.)

The situation in other countries may vary wildly, and in those cases gold might be quite good, or even great. ;)

[LuisGarcia]

Ahhh, the warm feeling of acheived agreement.

The circumstances of the individual investor are all important.

[mac_philo]

Heh, aww.

One case of country-specific gold attitudes is India. They are pretty peculiar because not only is storing wealth in gold very common (due to the history of anti-investor policies), but they often store it in the form of jewelry. Something like 30% of their GDP is in the form of jewelry. (!) Indian law has changed but people still hoard gold.

[Loren Pechtel]

Not really. By way of reply I ask you to go back 4 generations, and see what instruments were availble for you to invest in then. Now how many of them survive? I think you are confusing total civilisation collapse with the end of American economic hegemony.

The world has not ended in the last 4 generations. But, if your great great grandfather / mother was wealthy, and could have chosen one instrument to put their money in so that it would reach you intact with no further trading from anyone, what would your advice to them have been, had you been able to give it to them?

Your only advantage is that gold doesn't need to be managed. With remotely decent management the active or semi-active investor (these days you can invest in something like SPYDER and not worry about it other than the very small tax bill it throws off.) will be *FAR* ahead. A conservative estimate is that the stock market runs 5% ahead of inflation. Go back 100 years and what's the effect? That's time for about 7 doublings.

4 generations later the gold-horder has only 1% of the money the stock investor has. 1%. Does that sound like a good investment???

[YHWH666]

I have read about these european "wine-banks" that use rare wines in a similar way (this was in a work of fiction, so I'm not sure if they actually exist or whether this scheme would work out.) The bank puts almost all of it's money in these old wines which are stored in a secret vault. Since old rare wine is thought to only get better with age they always appreciate in value. Like with gold there is little or no risk. Unlike gold you have a slow trickle of increased value. Unless the wine market drops off at some point it should be a safe investment. Snoody rich types and posers have been wild about this stuff for centuries so I doubt that will happen any time soon.

What do you guys think?

[Loren Pechtel]

I have read about these european "wine-banks" that use rare wines in a similar way (this was in a work of fiction, so I'm not sure if they actually exist or whether this scheme would work out.) The bank puts almost all of it's money in these old wines which are stored in a secret vault. Since old rare wine is thought to only get better with age they always appreciate in value. Like with gold there is little or no risk. Unlike gold you have a slow trickle of increased value. Unless the wine market drops off at some point it should be a safe investment. Snoody rich types and posers have been wild about this stuff for centuries so I doubt that will happen any time soon.

What do you guys think?

See my post #27.

[mac_philo]

I don't see any real similarity between gold and wine banks. I think the idea will stay in the realm of fiction.

First, wine is fragile and can be destroyed.

Second, it's not true that wine indefinitely improves with age.

[PaineInTheBrain]

It seems to me that "investment" in gold can only work as an exception, rather than the rule. If everyone was "investing" in gold, they wouldn't be investing in actual production. You'd have a similar situation to the one that prompted Smith to write "Wealth of Nations," where everyone was attempting to become rich by hoarding gold, with the exact opposite result.

[theyeti]

This has probably been said already, but as someone who has argued with Ruy Lopez on this issue a number of times, I'll give my standard reply:

Over the long-term, gold is a terrible investment. Although its price fluctuates quite a bit, over the long run gold investments are unlikely to appreciate at a rate much higher than inflation. One up side to this is that prices are likewise unlikely to depreciate either, making it a safe way to store wealth, but the same can be said of T-bills and other government debt instruments. You are almost always better off holding these than you are holding gold; they usually give a greater rate of return and they are nowhere near as volatile.

Over the short term of course, you can make plenty of money speculating on gold the same as you can with any other commodity, be it silver, copper, sugar, or frozen concentrated orange juice. No one in his right mind however buys large amounts of frozen concentrated orange juice with the idea of holding it long-term, panning to use it for retirement, etc. Yet for some reason people do that with gold. Why?

Although gold has been used as currency throughout much of history and in many parts of the world still is, it no longer has this function in most advanced economies. The only reason to hoard gold is to protect against the extreme possibility of a collapse in the value of the dollar or other fiat currency. Since this is highly unlikely, the utility in holding gold is likewise very small.

People who like to buy up and hoard gold therefore tend to be paranoid types who expect a catastrophe to be right around the corner. They are typically of the bizarre belief that either 1) the world's fiat currencies, particularly the dollar and Euro, will collapse any day now due to economic disaster, monetary mismanagement, alien invasion, or any number of other wacky doomsday scenarios, and/or 2) fiat money by definition cannot hold any value, so it is inevitable that the world's fiat currencies must collapse -- all it will take is for everyone else to simultaneously agree with this premise, and people will quit accepting paper money and demand something of "real" value instead. Needless to say, these beliefs are stupid, and the people professing them are termed Gold Bugs (http://en.wikipedia.org/wiki/Gold_bugs) because their infatuation with gold constitutes an irrational obsession.

theyeti

[theyeti]

But, if your great great grandfather / mother was wealthy, and could have chosen one instrument to put their money in so that it would reach you intact with no further trading from anyone, what would your advice to them have been, had you been able to give it to them?

Land.

theyeti

[PaineInTheBrain]

People who like to buy up and hoard gold therefore tend to be paranoid types who expect a catastrophe to be right around the corner. They are typically of the bizarre belief that either 1) the world's fiat currencies, particularly the dollar and Euro, will collapse any day now due to economic disaster, monetary mismanagement, alien invasion, or any number of other wacky doomsday scenarios, and/or 2) fiat money by definition cannot hold any value, so it is inevitable that the world's fiat currencies must collapse -- all it will take is for everyone else to simultaneously agree with this premise, and people will quit accepting paper money and demand something of "real" value instead. Needless to say, these beliefs are stupid, and the people professing them are termed Gold Bugs (http://en.wikipedia.org/wiki/Gold_bugs) because their infatuation with gold constitutes an irrational obsession.

theyeti
LOL, truer words were never written. The second someone mentions the many virtues of gold and/or the gold-standard, I immediately file them under "woo."

[Gamera]

People who like to buy up and hoard gold therefore tend to be paranoid types who expect a catastrophe to be right around the corner. They are typically of the bizarre belief that either 1) the world's fiat currencies, particularly the dollar and Euro, will collapse any day now due to economic disaster, monetary mismanagement, alien invasion, or any number of other wacky doomsday scenarios, and/or 2) fiat money by definition cannot hold any value, so it is inevitable that the world's fiat currencies must collapse -- all it will take is for everyone else to simultaneously agree with this premise, and people will quit accepting paper money and demand something of "real" value instead. Needless to say, these beliefs are stupid, and the people professing them are termed Gold Bugs (http://en.wikipedia.org/wiki/Gold_bugs) because their infatuation with gold constitutes an irrational obsession.

theyeti
LOL, truer words were never written. The second someone mentions the many virtues of gold and/or the gold-standard, I immediately file them under "woo."

I'm for bi-metalism -- That will solve the problem:

"You shall not press this thorn of crowns on the brow of labor -- you shall not crucify mankind on a cross of gold!"