Erb and Harvey added the following: “The high and low real prices of gold highlight that even if there is on average a golden constant the real price of gold has strayed, and probably will stray, far from this possible central tendency. It is also possible that the future will be unlike the past.” They warn that if the “real price of gold falls, the golden constant level is not a floor—a protective line in the sand that the real price of gold will not cross.”

With this caveat, they went on to examine the outlook for gold returns given where the price is relative to the golden constant.

**Expected Returns To Gold**

Erb and Harvey examined what happened to the return on gold when prices were above or below the golden constant. As you might expect to see, the authors found that “below-average real gold prices have been followed by above average 10-year real gold returns” and “above-average real gold prices have been followed by below-average 10-year real gold returns.” The real price of gold is currently above its historical average, suggesting that, over the next 10 years, real gold returns seem more likely to be below their average.

Erb and Harvey also looked at the downside risk of owning gold. To do so, they asked: How low might the price of gold go if the previous low real price of gold is revisited? Given the value of the U.S. CPI for June 2015 (237.8) and the previous low real price of gold, they found a possible low price for gold of about $350 an ounce. This, of course, does not mean the price of gold would immediately decline to $350 an ounce. Rather, it’s simply a suggestion that, given the volatile history of real gold prices, the real price of gold once fell to 1.47 and it could fall to that level again.

The authors also examined what would happen if gold went back to its previous highest real price. If that occurred, it means the price of gold would again have reached about $2,080.

Erb and Harvey then looked at what would happen to real and nominal returns on gold if we assumed inflation of 2% per year over the next 10 years. Why 2%? It was roughly the difference between the yield on 10-year Treasurys and 10-year Treasury inflation-protected securities, as well as similar to the consensus forecast of economists gathered by the Federal Reserve Bank of Philadelphia.

**Assuming 2% Inflation Per Year**

Starting with the golden constant price of gold calculated using the June 2015 CPI level, they found that the golden constant value of gold would increase from $825 an ounce to $1,006 an ounce, and the “overshoot” price would rise from $350 an ounce to $427 an ounce.

If, over a 10-year investment horizon, the price of gold fell from $1,096 an ounce (gold’s nominal price in mid-2015) to $1,006 an ounce, it would experience a nominal return of ‐0.9% per year and a real return of ‐2.8% per year. Given that today’s price is $1,209 per ounce (an increase of 10% from gold’s price of $1,096 at the time Erb and Harvey did their original analysis), and inflation has increased by a much smaller amount, the return over the next 10 years would look even more dismal.

Erb and Harvey calculated that if the price of gold dropped from $1,096 an ounce to its 10-year “overshoot level,” the nominal and real returns would be ‐9.0% per year and ‐10.8% per year, respectively. Again, given today’s higher price of $1,209, the next 10 years would look even more dismal.

Erb and Harvey concluded that, even though there is little relation between the nominal price of gold and inflation when measured over 10‐year periods, the evidence suggests gold does hold its value over the very long run.