Swedroe: Debunking Gold Mythology

August 19, 2015

In mid-July 2012, Merrill Lynch added its voice to the many that were predicting gold would hit $2,000 an ounce by the end of that year. Francisco Blanch, head of global commodities research at the investment bank, said: “We think that $2,000 an ounce is sort of the right number.” Gold was then trading at about $1,577.

At about the same time, in an interview with ETF.com, money manager Peter Schiff, who has attracted much media attention with his doomsday forecasts, offered up this prediction: “I’m looking for another leg up … it’s going a lot higher. It’s hard to tell where the next move is going to take it. But it’s going thousands of dollars higher than it is now.” When asked how high, he responded: “I think a minimum of $5,000. But it could go a lot higher than that.”

These kinds of predictions almost certainly helped drive investor interest in gold. In fact, a 2011 Gallup poll found that 34 percent of Americans said gold was the best long-term investment, far more than those who chose real estate, stocks or bonds.

The question is: Were, and are, individuals investing in gold for the right reasons? Well, one reason for investor interest in gold is the belief that it’s a great inflation hedge. Another is that it provides a hedge against currency risk. And a third is that gold can act as a haven of safety in bad times. Are these valid reasons?

The Evidence

In their June 2012 study, “The Golden Dilemma,” Claude Erb and Campbell Harvey examined these issues. In terms of being a currency hedge, they found that the change in the real price of gold seems to be largely independent of the change in currency values. In other words, gold is not a good hedge of currency risk.

As for gold serving as a safe haven, meaning that it’s stable during bear markets in stocks, Erb and Harvey found gold wasn’t quite the excellent hedge some might think. It turns out that 17 percent of monthly stock returns fall into the category in which gold is dropping at the same time stocks have negative returns. If gold acted as a true safe haven, then we would expect very few, if any, such observations. Still, 83 percent of the time on the right side isn’t a bad record.

In terms of gold’s value as an inflation hedge, the following example should help provide an answer. On Jan. 21, 1980, the price of gold hit a then-record high of $850. On March 19, 2002, gold was trading at $293, below where it was 20 years earlier.

Note that the inflation rate for the period from 1980 through 2001 was 3.9 percent. Thus, its loss in real purchasing power was about 85 percent. How can gold be an inflation hedge when, over the course of 22 years, it loses 85 percent in real terms?

As further evidence of gold’s inflation hedging abilities, Goldman Sach’s “2013 Outlook” contained the following finding: In the post-World War II era, in 60 percent of the episodes when inflation surprised to the upside, gold underperformed inflation. That said, gold has been a good hedge of inflation over the very long run (such as a century). Unfortunately, that’s a much longer investment horizon than that of most investors.


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