Is Gold a Good Investment?


In the last few months, we’ve seen a resurgence in the price of gold, which has naturally led to many investors asking the question, “should I own gold in my portfolio?”  Given the recent massive government spending, the fear of inflation is rising which I discussed Here.  A natural reaction is to want to protect against inflation by owning “Real” assets, the most prominent of which is gold.  One would think gold would be one of the things most agreed upon within the investment community.  After all, it’s relatively finite, it has great historical data, there are no projected earnings to squabble over…a gold bar today looks like it did 100 years ago and will 100 years from now.

So why is there so much disagreement about the value of gold?  It’s because the history of gold has varied greatly.  Someone can tell you they got rich buying gold, while someone else can tell you they lost everything, and they can both be telling the truth.  The real truth is, that despite it just being a metal with a known quantity and no earnings surprises, gold is still an extremely volatile asset.  While many claim that it is just a great inflation hedge that will perform well when other assets fail, the reality is that the price of gold is driven primarily by speculation; its history is riddled with periods of huge booms followed by times of huge busts. As a result, one can easily torture the data to get it to show whatever narrative they want to tell. My goal is to lay out the data in its entirety and provide an unbiased analysis of how gold has performed, which will hopefully provide a reasonable framework for what to expect.


From the 19th century until 1971, the US was on a gold standard which meant every dollar of currency was backed by physical gold held in the federal reserve, and thus the price of gold was basically set at static dollar amount by the US government for this entire time period.  FDR inflated the currency in 1932 to combat the great depression and established $35/oz as the price of gold, and that is more or less where it stayed until 1971 when President Nixon abolished the gold standard.  This allowed individuals to freely own and exchange gold and led to the price being set through the mechanisms of free markets. This led to a huge spike in the price of gold over the rest of the 70’s.  This happened to coincide with the highest inflationary period in our recent memory, so undoubtedly there were several contributing factors.  Below shows the growth of $1 of gold alongside the growth (inflation) of $1 USD from 1971 – 1980

During this 10-year period, $1 of gold grew to $18, which equates to a 1700% return.  At the same time, One dollar inflated all the way to…Two dollars.  This huge spike was caused in small part by inflation, in some part by the free market finding a reasonable price after the removal of the gold standard, and in large part by a speculation bubble.  So what happened next?  The bubble popped.

Over the next 18 months, the price of gold dropped by > 50%, while inflation continued to rise.  However, this isn’t the end of the story.  20 Years later, gold was still down > 60% from its 1980 peak, while inflation continued to climb upward, meaning the real inflation-adjusted return was even significantly worse.  In fact, it took a full 27 years for gold to just breakeven from its previous high. This is the earmark of speculative assets; prolonged periods of low or negative returns with spikes in value interspersed throughout.  This trend continued over the next 20 years. Gold performed great from 2005-2011 coinciding with difficult economic times of the housing bubble and financial collapse, followed by another significant drop until the resurgence over the recent months.

So what do we know?

  • The long-term return of gold should be equivalent to inflation.  Gold has no intrinsic value, no earnings, and no expected real return.
  • It experiences extreme volatility.  The price of gold can draw down significantly, and experience prolonged negative returns.
  • This volatility make gold a poor inflation hedge.  As shown by the graphs above, there has been little to no correlation between inflation and gold.
  • It can perform very well for short time periods, and this tends to coincide with poor or volatile economic times.
  • These positive returns are purely speculative.
  • To win at speculation, you have to be right twice.  You have to buy before the run-up and sell before the drawdown.

So do the pros of diversification and potential positive returns during bad times warrant a place for gold in an investment portfolio?  I am of the opinion that it does not.

As a long-term (buy and hold) investment it does not have positive expected real return, and it has significant volatility and downside exposure.  Any diversification benefit its inclusion may provide is not enough to overcome these negatives.  To put it more simply, gold will have a negative impact on an otherwise well-constructed portfolio much more often than it will have a positive impact.

As a short-term strategic investment, unless you have a crystal ball, it is very difficult to do well.  Speculation is a zero-sum game.  Someone is on the other side of the trade that thinks the price is going in the opposite direction.  Gold prices increase when there are more buyers than sellers and vice versa.  Your ability to do well relies on buying based on correctly predicting more future buyers than sellers, and then selling before that changes.  Speculation is closer to gambling than investing, and not something I’d recommend with ones hard earned savings.

Source: DFA Returns web.

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