Swedroe: Don’t Be Distracted By Gold’s Glitter

March 17, 2017

For example, in a prior paper, they presented historical evidence that the wage of a Roman centurion (in gold) was approximately the same as the pay earned by a U.S. Army captain today. They also showed that the price of bread (again in gold) thousands of years ago was about the same as we would pay today at an upscale bakery.


The conclusion we can draw is that, while gold might protect against inflation in the very long run, 10 years—or even 20 years—is not the long run. Erb and Harvey note: “In the shorter run, gold is a volatile investment that is capable and likely to overshoot or undershoot any notion of fair value.”

I would add to that another insight that becomes important in the long term. While the laws of economics can be defied in the short term, history demonstrates that investors ignore them at their peril. For instance, a basic economic principle is that, over the long term, prices tend to move toward the marginal cost of production.

In their “2013 Outlook,” Goldman Sachs observed that more than 80% of gold production costs less than $1,000 an ounce—or about 20% below the current price.

Here’s another data point. In June 2016, Pavel Grachev, chief executive of Polyus Gold, the largest gold producer in Russia and the world's lowest-cost gold producer, told CNBC: “Our so-called total cash cost is about $400 per ounce.” He then added: “However, we keep reducing our costs.”

Another important point to consider is that, unlike with other commodities, all the gold that’s ever been mined is basically available for sale today.

The recent revolution in energy production created by new fracking technology provides another reminder of how technology can change the whole supply/demand curve. As Dimensional Fund Advisors’ Weston Wellington pointed out: “It’s also conceivable that a significant real price increase would encourage development of electrochemical extraction of the estimated 8 million tons of gold contained in the world’s oceans, dwarfing the existing gold supply.” That’s a lot of supply that could potentially hit the market.

The bottom line is that, while my crystal ball always remains cloudy, based on the fundamentals and the historical evidence, there doesn’t really seem to be a case that gold is likely to provide strong investment returns, even though it has already fallen about 36% from its peak nominal value (and even more in real terms). Forewarned is forearmed.

If you have been considering an investment in gold—perhaps you see the sharp drop from its 2011 high as a buying opportunity—hopefully the information in this article will enable you to make a more informed decision.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


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