Why All the Interest in Gold?

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Why All the Interest in Gold?

Larry Swedroe Aug 04, 2015

Because so many “gurus” who appear in the financial media make predictions focusing on the direction of gold prices, today we’ll discuss some more commonly held beliefs about this precious metal in an effort to determine whether or not they hold up under closer scrutiny.

Belief: Gold is an Inflation Hedge

For example, on January 21, 1980, the price of gold hit what was at the time a record high of $850. On March 19, 2002, gold was trading at $293, way below where it had been more than 20 years earlier. The inflation rate for the period from 1980 through 2001 was 3.9%. Thus the loss in real purchasing power was about 85%. How can anyone claim that gold is an inflation hedge when, during a 22-year period, it lost 85% in real terms?

And while we’re being selective in choosing our period start date, it’s now been more than 35.5 years since gold first hit $850 an ounce. With gold today trading at about $1,100 an ounce, that’s an increase of just 29%. In other words, gold has increased about 0.7% per year in nominal terms since that date in January 1980. During this period, inflation has increased at a rate of about 3.2%. That means gold has now provided negative real returns for the past 35.5 years, losing about 2.5% a year, producing a total loss in real terms of about 60%.

Belief: Gold is a Currency Hedge

Belief: Gold is a Safe Haven

The Cost of Gold

They also noted that more than 80% of gold production costs less than $1,000 an ounce, about 10% below the current price. It is possible there’s validity to the claim by gold bugs that gold is under-owned by investors (such as central banks) and that even a small shift in demand could lead to a significant rise in the real price of gold, assuming supply is inelastic (a big assumption).

However, we must also keep in mind that almost all the gold ever produced is available for sale. And, as Dimensional Fund Advisors’ Weston Wellington, pointed out: “It’s also conceivable that a significant real price increase would encourage development of electrochemical extraction of the estimated 8 million tons of gold contained in the world’s oceans, dwarfing the existing gold supply.” That’s a lot of supply that could potentially hit the market.

The Bottom Line

On the other hand, if you’re considering making a strategic investment in gold as part of your long-term plan, and you are a disciplined buy, hold and rebalance investor willing to accept the risks that gold could collapse and stay down for a decade or two, then gold might merit a small allocation.

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