Gold is a bad investment, even in bad times

Gold doesn't offer the protection you may think. Here's what changed my mind on the yellow metal, and why I sold out this week.

I used to be a believer in gold. Not quite a ‘gold is going to make me rich’ believer – I knew there was little investment merit compared to productive assets like stocks, as we’ll get to in a moment. But I could still see some sense in having a few percent of my portfolio in SPDR Gold Shares (NYSE: GLD).

This ETF, I reasoned – which is backed by physical gold – would act as an insurance policy against hyperinflation or social unrest. If the world goes to pot, at least I would own one asset that does well in bad times, right?

Wrong, it turns out. As Jason Zweig explained in last week’s The Wall Street Journal, gold isn’t a very good hedge against crises. In September 2011, when Standard & Poor’s downgraded the US Government’s credit rating, US stocks fell 7% – yet gold dropped 11%. And in October 2008, when the global financial crisis was in full swing, US stocks lost 17%, while the gold price fell 19%.

Stranger still, the gold price at the end of October 2008 was around 44% below where it is now, and, in September 2011, around 25% higher. As Zweig rightly asks, ‘is today’s chaos that much worse than the financial crisis? Was the summer of 2011 so much darker than today?’

In two paragraphs, Zweig had undermined the only argument for owning gold that I was clinging to – that it was insurance against disaster. I sold out of GLD completely.

Arguments against gold

The trouble with owning gold is that without the ‘something to stitch into your garments during wartime’ argument, there isn’t much else going for it. Here’s a few reasons why gold makes a bad investment:

1. Poor protection against inflation. One of the main arguments you hear for owning gold is that it maintains its purchasing power over time, unlike cash, which loses its value due to inflation. That’s true to an extent – over hundreds or thousands of years, gold has maintained a fairly steady value relative to the cost of living. But on a time scale useful to investors – 5, 10, even 40 years – gold is actually a terrible hedge against inflation; the gold price is far too volatile. Adjusting for inflation, gold is still 44% below its peak in 1980. 

2. It’s a speculation. The fundamental problem with owning gold is that it isn’t a productive asset. If you buy an ounce today, 50 years from now you will still have just that one ounce. Gold does have some industrial uses, but demand for these purposes is low compared to the world’s gold production. Ultimately, the gold price is driven by investor sentiment, not utility. Buying gold is a speculation that someone else will some day pay more for it than you did.

3. Opportunity cost. If you intend to buy physical gold or a gold ETF, you should consider what other assets you can buy that have a better chance of compounding your money. Warren Buffett put it best:

"I have no views as to where [gold] will be, but the one thing I can tell you is it won't do anything between now and then except look at you. Whereas Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money … It's a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that."

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