Last month, The Wall Street Journal published an article entitled “When the markets get scary, mom and dad buy gold.” (The Journal’s print version carries the more sober headline “Individual Investors Seek Safety in Gold.”) The article underpinned the news that, for the first time in 10 years, Gallup poll respondents preferred gold to stocks when asked to name “the best long-term investment.”
Given that gold has returned less than stocks over the past 10, 20, 30, 40, 50, 60, 70, 80, 90 and 100 years, counting both domestic and international stock markets, we This response can be interpreted as indicating either that the public believes that traditional investments will soon collapse or that, although it sacrifices total return potential, gold provides a level of protection that stocks lack. The author of the Journal favored the latter solution, which seems to me to be the right choice.
Therefore, the story featured investors praising the reliability of gold. In particular, his main quote struck me: “Precious metals are kind of what lets me sleep at night,” said a middle-aged engineer from Massachusetts. “It is impossible (if I have gold) to find myself in a bread line somewhere, waiting for someone to drop something into my hand so I can eat.”
Consider this statement.
1) Short-term volatility
Usually, financial risk is assessed by short-term movements. There are good reasons for this practice. Assets that fall 20% in a week are much more likely to suffer serious future losses than those that never fall 5%. (Assuming, of course, that Bernie Madoff isn’t the accountant.) Additionally, many investments must be judged based on what’s happened recently, because they lack long-term history.
The following chart shows annualized monthly standard deviations, since September 1971, for four asset classes: 1) gold bullion, 2) medium-term U.S. government notes, 3) international stocks, and 4) U.S. stocks. I used this start date because in August 1971, President Nixon announced the “temporary” suspension of the Bretton Woods Agreement. This interruption quickly became permanent, creating a new gold price regime that still exists today.
According to this statistic, gold is riskier than stocks. The difference isn’t huge — for example, gold has been less volatile than tech stock indexes — but it nevertheless seems to refute the engineer’s assertion. Conventional analysis indicates that gold bullion is a relatively dangerous security. (Gold mining company stocks are even luckier.)
But this investigation is insufficient. After all, the engineer didn’t care about monthly fluctuations. What worried him was the possibility of a one-way move, resulting in the loss of his capital. Although related, the two elements are not identical. It could be that gold prices fluctuated wildly in the short term and then reversed toward the mean. If this is the case, gold would indeed be a safe choice according to its barometer.
2) Long-term depreciation
We can test this hypothesis by measuring the weakest long-term performance managed by gold over the study period. On an inflation-adjusted basis (nominal returns are not important, because what matters is the preservation of purchasing power), what was the lowest result over 10 years for a $100,000 investment in gold ingots ? For comparison, I included three other assets: U.S. medium-term bonds, foreign stocks, and domestic stocks.
The engineer would be unhappy. During its worst decade, gold bullion lost almost half its real value. Stocks, too, suffered losses at times, although at different times than gold, but their lows were nonetheless higher. For investors who needed their money back after 10 years, gold was the most dangerous of the four assets.
The 20-year view was even worse. Gold fell further, to just 41 cents on the dollar. At the same time, the real returns of the three competing investments have been consistently positive. Domestic stocks have been particularly spectacular, returning at least 154% over every 20-year period. They, not gold, were the safer choice.
One might argue that the 10- and 20-year gold lows each began in the early 1980s, when bullion prices soared. Thus, these findings are misleading because they are based on a single moment in half a century of history. Yes and no. Although it is true that the worst long-term results came from that year, most of those who bought gold between 1979 and 1983 also lost money, after inflation, over a period of 20 years.
3) In the midst of disasters
I don’t have a chart for the third and final assessment: how gold performs when normal investment rules no longer apply, such as during periods of total war or hyperinflation. Not only have such calamities rarely troubled developed countries over the past century, but when they do occur, the barter rate for gold has not often been documented. The data only allows for guesswork.
However, based on anecdotal evidence – including my mother-in-law’s experience as a refugee from World War II, when she survived on meals purchased with gold coins from her attic mother – I will give gold its due. In the event of a total catastrophe, gold should prove superior to both paper dollars and electronically stored cryptocurrencies. Sometimes tangible assets outweigh intangible promises.
But these scenarios seem highly improbable to me. However, I can neither deny the possibility nor the fact that if a calamity occurs, I will regret my decision not to own precious metals. Under these conditions, the engineer’s portfolio will outperform that of your humble (so-called) investment expert.
In short, the decision to invest in gold comes down to 1) the probability an investor assigns to the prospect of international catastrophe and 2) the investor’s comfort level in ignoring this possibility. As an optimist, I find it an easy decision: move forward without it! However, I appreciate others having different views. For them, a spoonful of bullion can bring comfort worth its weight in gold.
However, based on the evidence presented in this article, I don’t think the case for gold goes any further than that.
The opinions expressed here are those of the author.