Image Credit: Christophe Vorlet
By Jason Zweig | July 8, 2016 11:10 am
Almost exactly a year ago, this column called gold a “pet rock” and said investing in it is “a leap in the dark.” Gold traded then around $1,130 an ounce. This past week, it surpassed $1,360. Gold is up 20% since I ridiculed it; the U.S. stock market, measured by the S&P 500 with dividends reinvested, is up less than 1%.
If you’re wondering, perhaps not for the first time, whether Jason Zweig is a moron, rest assured that you aren’t alone. I’ve been wondering that, too.
The deeper question raised by such a howlingly bad short-term call isn’t about gold itself. It is, instead: What makes an investing decision wrong?
A sharp change in price isn’t proof enough. If you bought Apple as a long-term turnaround when it rolled out the iPod in October 2001, you would have suffered through a 25% cumulative loss, including two one-day price declines of more than 15%, over the next year. The short-term price action said you were wrong, but your long-term logic turned out to be right: The stock is up better than 7,900% since then.
So you are wrong only if the price moves against you and your original rationale no longer makes sense.
In that light, let’s review what gold is and what it isn’t.
Gold is insurance against chaos. Continually traded for millennia, it has tended to do well during periods of financial stress. Gold has also preserved its purchasing power over remarkably long periods. The same quantity of gold that a Roman centurion earned annually under Emperor Augustus (27 B.C. to A.D. 14) would cover one year’s pay ($46,500 to $65,000) for a U.S. Army captain today.
And the world is certainly in chaos, with the British voting to exit the European Union, central banks struggling to revive economic growth and roughly $12 trillion in government debt carrying negative yields.
“Just like Brexit came out of the blue, there will be other surprises that will show that the surface calm and sanguine view are not sustainable,” says John Hathaway, portfolio manager of the $1.7 billion Tocqueville Gold Fund. “When investors ask, ‘How do I protect capital?’ it all comes back to gold.”
With central banks around the world holding about 33,000 metric tons, gold is also an implicit form of money. Like most nations, the U.S. went off the gold standard decades ago. But if markets lose faith in national currencies, policymakers could — in theory — again choose to make money convertible to gold.
However, some important popular beliefs about gold aren’t supported by historical evidence.
While gold is a reliable store of value over extremely long periods, most investors don’t lock their money up for a couple thousand years at a time. In the shorter term, gold fluctuates so wildly that it is a surprisingly poor hedge against increases in the cost of living.
From its peak of more than $800 as inflation raged in 1980, gold fell relentlessly over the next two decades even as the cost of living continued to rise. Adjusted for inflation, gold remains 35% below its record highs of 1980, says Claude Erb, a former commodities and fixed-income portfolio manager at TCW, the Los Angeles-based investment firm, who has extensively researched gold’s historical performance.
And gold is a partial, not a perfect, hedge against chaos. In October 2008, for instance, when U.S. stocks fell 16.8% and corporate bonds lost 4.5%, gold dropped 18.5%; in September 2011, as U.S. stocks fell 7% and corporate bonds gained 1%, gold dropped 11.4%.
In October 2008, the depths of the global financial crisis, the gold price was 30% lower than it is now. In August 2011, when Standard & Poor’s downgraded the U.S.’s credit rating, gold was nearly 40% higher than it is now. Is today’s chaos that much worse than the financial crisis? Was the summer of 2011 so much darker than today?
Investors are rushing to gold as if the chaos will only worsen from here and the yellow metal is a panacea against it. SPDR Gold Trust, the exchange-traded fund that provides convenient exposure to gold, took in $3.3 billion in new money last month and a total of $12.2 billion in the first half of 2016 — more than all U.S. stock ETFs combined during the same periods.
The future can always be different from the past. But if gold shoots far up from here, it won’t be following the precedents of the past. It will be violating them.
So am I a moron? On many things, yes. On gold, I don’t think so.
Source: The Wall Street Journal, http://on.wsj.com/29w7RSz
For further reading:
Peter L. Bernstein, The Power of Gold
Claude B. Erb and Campbell R. Harvey, “The Golden Dilemma”
Christophe Spaenjers, “The Long-Term Return to Durable Assets”
Howard Marks, “All That Glitters”
William J. Bernstein, EfficientFrontier.com, “Wild about Harry”