"No man can become rich without himself enriching others"
Andrew Carnegie

Saturday, July 6, 2013

In Defense of Gold... and “Gold Bugs”

Gold Key, weighing one kilogram is used to acc...
Gold Key, weighing one kilogram is used to access a ten digit account number which is known only to the bearer of the Gold Key. (Photo credit: Wikipedia)
By Investment U

"Gold isn't such a hot inflation hedge."

- Alexander Green

Chicago, Jul.6, daily stocks .- In his July 1 Investment U column, "Why You Still Shouldn't Listen to Gold Bugs," Alex Green made the bold statement that gold has been a lousy inflation hedge.

He wrote, "It hit a high of $875 an ounce in January 1980. And even though we experienced double-digit inflation that year, it lost a third of its value by Dec. 31. And it kept dropping for almost 20 years.

Gold bugs who purchased gold at the high 33.5 years ago still haven't broken even in inflation-adjusted terms. Heck, they still hadn't even broken even when gold peaked above $1,900. If that's an inflation hedge, I'm Woodrow Wilson."

Alex argued that investors should choose stocks over gold. Stocks, he said, are a "genuine inflation hedge."

Gold and Inflation

I agree with Alex on one thing: Stocks are a superior inflation hedge over the long run because they represent a growing economy.

U.S. stock indexes have outperformed gold by a long shot (although I should add that a sharp rise in inflation can hurt stocks for years - witness the 1970s and early 2000s).

But I think he's wrong about gold as a long-term inflation hedge. Granted, if somebody had the misfortune of buying gold at the top at $875 an ounce in 1980, or $1,900 in 2011, his investment has indeed proved to be a lousy bet.

Yet if a smart investor had bought gold at $35 an ounce in 1970, as Harry Browne and other astute gold bugs recommended back then, today's price of $1,240 an ounce doesn't look too bad - it presents a 34-fold increase over a 43-year period.

Gold has traditionally held its purchasing power over long periods of time. The classic study on the subject is The Golden Constant, 1560-1976, by Professor Roy Jastram, and updated through 2007 by the World Gold Council. The following purchasing power of gold chart demonstrates how the yellow metal has done over the long term:

There are two things to notice about this chart. First, between 1792 and 1971, the long-term purchasing power trend for gold was relatively flat (around 1.0 on the chart). Jeremy Siegel comes to the same conclusion in his Stocks for the Long Run.

Second, since 1971, when the world went off the international gold standard, gold has become an outstanding inflation hedge. Since 1971, it has done a lot better, despite its volatility.

Benefits of Gold

According to the chart, gold at $1,240 an ounce today has grown approximately 3.3 times its real value since 1971. Of course, U.S. stock indexes have done even better, but gold is no slouch.

Another benefit of investing in precious metals is that they offer a wonderful forced savings plan. Over the years, I've asked audiences at investment conferences (including the annual Investment U conference) how many of them have purchased gold and silver coins. Usually about half the people raise their hands.

Then I ask, "How many have sold any gold or silver?" Almost every hand goes down. People tend to buy coins, but not sell them because of the hassle and tax implications.

You can't say the same about stocks, which people buy and sell like crazy.

Here's another thing to contemplate: Every piece of gold jewelry or coin ever made still has value. Can you say the same thing about stocks or bonds?

My recommendation: Buy gold and silver coins from a reputable dealer and hold them for the long term as an insurance policy against bad times. But don't go overboard - invest no more than 5% of your portfolio.

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