Suggested Reading by Kelly C. Ruggles Back to Article Main Page
Gold Is All The Rage, But It May Not Be A Good Inflation Hedge
Gold has been on a roll this year, hitting an all-time high of over $1,200 an ounce early in December. Investor demand has been so great that the U.S. Mint had to stop producing some popular gold coins due to supply difficulties.
Investors are buying gold as a hedge against inflation and against another financial disaster. But how good is gold's record in protecting an investor's portfolio in the long term? Not very good, it turns out.
Despite gold's 25 percent climb in 2009, an investor who bought gold the last time it hit a high, almost 30 years ago in 1980, could have done better putting her money in an interest bearing checking account.
That's right: the gold investor earned a total of only 44 percent over that long period, while the average interest-earning checking account grew by 92 percent, according to figures compiled by Bankrate.com.
No inflation hedge
What's worse, gold failed to protect an investor from inflation over the last 30 years. After adjusting for inflation, the 1980 gold buyer is still 79 percent below where he started, reported Bloomberg.com recently.
Meanwhile, U.S. stocks went up 22-fold over that same period: the Standard & Poor's 500 Index increased by 2,182 percent between gold's last high in 1980 and December 2009. Even super-safe U.S. Treasury securities did much better than gold over this period, gaining 1,089 percent vs. gold's gain of just 44 percent.
Gold is a non-productive asset, which makes holding it over a long period costly. Bonds and other interest bearing investments make regular income payments. Stocks pay dividends and offer a share in a company's profit growth through capital appreciation. Neither investment has any carrying cost, while gold is costly to store and protect.
Also, gold has had some very violent swings over the years, making it quite volatile. From 1971, when President Nixon abandoned the gold standard, through January 1980 its price went from $35 an ounce to a high of $850. It fell in subsequent years, hitting a low of $252 an ounce in August 1999.
The recent run-up in gold seems to have a lot to do with the publics fear that the U.S. government's huge borrowing during the recent financial crisis will either cause the currency to collapse or inflation to soar.
Using gold as a hedge against a collapse of the dollar fails the reduction ad absurdum test: if the currency fails what would an investor translate his gold holdings into in order to spend it? Would he hide hundreds of pounds of gold coins under his bed or in a hole in the backyard?
Gold also fails as a long-term inflation hedge. "The history of gold in regard to inflation shows that it's not a great hedge," Maxwell Bublitz, chief strategist for SCM Advisors, a $3.5 billion investment firm, recently told Bloomberg news service. Instead, stocks, especially stocks of small companies, tend to do well in inflationary periods. Also recommended for diversification are broad-based holdings commodities, including commodities that have use and scar-city value like oil, grains, coffee, and industrial metals.