Can you rely on the safety of gold, or is it a myth?
Gold may be a good investment at times, says a Canadian analyst, but the idea that it can protect us from inflation or depression is a myth.
Gold took it on the chin yesterday.
It wasn’t the only victim, of course. Just about every commodity or security you could imagine was tossed overboard in the wake of the galloping anxiety over Japan.
But in times of trouble gold always has its day. And the question inevitably comes up.
If you believe that the economy and the markets are threatened, should you seek safety in gold?
Many “gold bugs” will tell you that you should stock up on gold even when the economy is booming. The price is going up and up and up.
Others insist that at least some corner of your portfolio (generally 10 per cent or so) should be hedged with gold against any future uncertainty.
But one seasoned investment executive doesn’t see the glitter.
Mr. John Sartz believes the value of gold as a protective investment has been exaggerated. Writing in Investor's Digest of Canada, he explains why gold hasn’t lived up to its reputation.
It’s all a matter of perspective, he says.
The problem with gold
About three decades ago, Mr. Sartz informs us, economists were building models (as only economists can do) that would gauge expectations for inflation. The models had some value, since they helped bond investors estimate the after-inflation return built into bonds.
The problem with these models, the analyst says, is that they gauged how investors were forecasting inflation, not how they ought to do it. That is, they were based on recent data instead of long-term observations.
And that’s the problem with gold.
Recently, Mr. Sartz heard a journalist discussing the fact that gold was riding above US$1,400 an ounce. To add drama to his story, the journalist noted that five years ago, gold traded at just $250 an ounce.
This is hype, not perspective, says Mr. Sartz. “However, it did give ample evidence that investors tend to focus on the recent past. Certainly a quintupling in price in five years is impressive.”
Yet it would have been equally useful to inform listeners that 30 years ago gold was trading at US$800 an ounce (which in the moulted Canadian dollar of the day was $960).
The fact is, a Canadian buying gold in 1980 would have had a total return of less than 50 per cent, or 1.3 per cent per annum, in the past three decades.
“I would not venture to come up with a major asset class which, over the same time period, has done as badly.”
Call him cynical
Unhappily, a short-term view of history is the rule rather than the exception among investment advisers and journalists, says this analyst. So you will hear plenty more investment pros in the business media telling you to burrow into gold for protection.
The point of this exercise, he adds, is to protect you against “the inherent volatility of the stock market.”
But over the past three generations, stocks have never declined more than 50 per cent from peak to trough.
At the same time, gold declined more than 75 per cent from its 1980 peak. As recently as five years ago, it could be bought at a withered 30 per cent of that price.
“Call me cynical,” says Mr. Sartz, but he fails to see how this “somehow constitutes a rational protective strategy.”
Believe it or not
This doesn’t necessarily mean that gold is a bad investment, the analyst admits. It does mean that it’s not much of a defensive investment.
“If defense is on the agenda, it seems to me one should be able to find less volatile assets than gold.”
In fact, gold has been a great offensive investment to own over the past five years, he concedes. “Regrettably, however, no one has yet figured out how one can purchase past performance.”
Mr. Sartz does not profess to be an expert in gold. But he does note that it has one problem as a commodity. It is not widely consumed. 99 per cent of the gold ever extracted on this planet is still with us.
“It serves no earthly purpose other than as a store of value.”
The idea that gold will somehow perform well in inflationary times and also reward owners during deflation and depression “is a myth,” he goes on to tell readers of Investor's Digest of Canada.
In effect, you take your chances with gold just as you do with any other investment, Mr. Sartz concludes. When you invest in gold, you should “face the fact that your response is emotional rather than rational. Investment in gold is kind of like religion. You either believe or you don’t.”
This morning gold gained back $10 of the $32 that it lost yesterday to rise back above $1,400. Somebody believes in gold. But does that belief translate into enduring value? At least one analyst would say no.
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