Should You Invest in Gold?

By now, you have either put a little of your precious savings into gold or you have thought about it seriously. With the advent of gold ETFs (technically a misnomer, they are not truly Fs) it Goldvault_nychas never been easier to buy and sell the stuff. And at around $1200 an ounce, gold is up an impressive 50% or so since the fall of ‘08 and has gained an annualized 12.4% a year for the past decade.

Of course, for most investors, the fact that gold has done well lately is more or less the entire argument in favor of buying it. Subtle justifications are available, but, let’s face it, none of them are as powerful as the primal urge to join the party while you still can.

But when you get down to it, gold is one the more peculiar investments out there. Although it is an exaggeration to say that it is a substance of no intrinsic value, it has several industrial uses and would undoubtedly have many more if it were not so expensive, gold lacks some basic characteristics of a typical investment.

In particular, owning it promises no economic benefit other than the hope that you will be able to sell it later on for more than you paid for it. To be sure, that motivation is behind much conventional investing, but for most assets there is a background hum of economic rationale, a reason why somebody might want to own the thing even if it did not appreciate.

A stock is a share in a company and, by extension, a share in its profits. When you own a share of Apple, you own about $12 in annual profit. $250 may be a lot to pay for that, but nobody is going to suggest that Apple has no intrinsic value at all. Similarly, a bond will pay you interest for a number of years.  Real estate can be lived in, or farmed, or used for offices. Even fine art gives pleasure to those who admire it. (Or so I am told.)

Gold just sits there. If you buy actual coins and bars you can spend your evenings fondling it, but most investors today do not even get to do that. They purchase financial instruments that represent ownership of some gold in a dark vault deep underground somewhere.

The comparatively sophisticated argument in favor of gold is that it is the ultimate hedge against bad things happening to the rest of your portfolio. When it really hits the fan and panic sets in (e.g. fall 2008) gold goes up, and is often just about the only thing that does.

While this is certainly true as an empirical observation of what has happened in the past, it strikes me as a weak investment thesis. It relies too heavily on panicked investors following convention. People consider gold to be a safe haven investment only because they believe that everybody else does. If they start to doubt that and notice that gold is actually comparatively volatile and of marginal economic value, then the whole thing could come crashing down.

That has not happened yet, and I am not predicting it in the near future, but it is certainly possible and that possibility pretty well undermines the role of gold as portfolio lifeboat. And for all the recent excitement, the long term trend for gold as investment of last resort is negative. On an inflation-adjusted basis the recent peak of $1257 is still  below the $599 1981 peak, which comes in at about $1400 in today’s money.

A goldbug would probably argue that being under the 1981 high means there is more appreciation to come. I take the view that even in a financial dislocation that is by most measures worse than that of 1981, gold turned out to be less popular. That does not bode well for the next time ‘round.

And there is no shortage of ways to insure against meltdown. You could just short the market. ETFs are made for shorting. Or buy put options. Treasury bonds, particularly the inflation protected varieties, make good hell-or-high-water stores of value, and you get interest checks twice a year.

A long time ago, it may have been in 1981, I heard a radio interview with a “survivalist” expert giving advice on how to prepare for the immanent end of civilization. The interviewer asked if people should hoard Krugerrands. You could almost hear the survivalist rolling his eyes. He replied with something like “Look, there is no guarantee that anybody is going to want bits of shiny yellow metal. What you want to save up are useful things that are small, durable, and very hard to make by hand. I recommend razor blades. Gold just isn’t really worth anything.”

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