April 15, 2014
April 15, 2014
Yesterday’s bulls are now today’s bears. After breaking through $1,900 per troy ounce in September 2011, gold has since fallen back toward earth and now hovers around $1,250 per troy ounce. Gold bugs are undeterred and say that now is the time to buy. What’s their rationale?
In short, we live in uncertain times. The global economy is weak, developed world unemployment is high and the participation rate is low, debt levels are troubling before even considering unfunded entitlement liabilities, and new regulations are still in digestion. In the meantime, the Federal Reserve continues to expand the money supply, adding $65 billion per month to its $4 trillion balance sheet. With the U.S. treasury printing dollars to accommodate these initiatives, some speculate that inflation is imminent – a bullish argument for gold as a hedge against the devaluation of the dollar. Others point out that deflation is the real story, highlighting low bond yields and stagnant median incomes. In such times, it is said that gold’s stability may shine because, in contrast to printable dollars, the supply of gold is relatively fixed and determinable.
Above the short term uncertainty, gold is yet to prove itself worthy of long term investment. As John Bogle (founder of The Vanguard Group) points out in his book, “Common Sense Mutual Funds: 10th Anniversary Addition,” over the last two centuries (since 1802), a $10,000 investment in gold would only be worth approximately $30,000 in real terms (meaning adjusted for inflation). This is compared to the same amount invested in the U.S. stock market, for which the value would be over $8 Million. The staggering differential in return is best attributed to yield. Stocks are investments in companies that make goods or provide services, yielding profit to distribute to investors or to reinvest in the business. This has a compounding effect that gold lacks. Further, unlike commodities such as oil, gold has no real industrial application, and is therefore not depleted over time.
Is the human affection for gold an enigma or is the market simply suggesting that prospective investment returns in gold will be superior to its history? Perhaps it is a bit of both. As noted above, the long term historical returns in gold are underwhelming; however, as with most commodities, there are times of great volatility, which present the opportunity for market timers to seek significant short term returns. Recall in early 2000, when seemingly endless returns could be made in the technology boom; then out of favor, gold hovered below $300 a troy ounce. At today’s prices of around $1,250 a troy ounce, this would have provided a long period of successful returns, especially in comparison to the returns in the U.S. stock market, which fell in half, twice, during that time period.
As with all investments, we leave speculation and short-term strategies to the market timers. Looking through a long-term lens and acknowledging the current economic times, a modest allocation to gold and other commodities as part of one’s comprehensive diversification may be appropriate. If history is any lesson, cycles repeat themselves. With great periods of return come offsetting droughts. Particularly evident with gold, while upward cycles are often married to economic turmoil, downward cycles can be coupled with green shoots and a lasting economic recovery. Perhaps a prolonged contraction in gold prices will be emblematic of a U.S. economy that has finally turned the corner on unemployment, financial leverage, and fiscal order.