There are people out there – and no small number of them – who are practically cheerleaders for gold. Whatever the problem, or the state of the economy, gold is the right investment to own.
But is that even close to reality?
Or is gold over-hyped?
I think gold is over-hyped. I’ve done an analysis here that I believe proves my point.
There seems to be a time and a place for owning gold, but there’s little evidence of the need to own it at all times, and in any significant amount.
Fear and Greed – And Gold
When you look at the facts surrounding gold as an investment, it’s mostly a play on the emotions.
With gold, the primary emotion is fear.
Gold does have a history of performing well when financial assets sink. If you can peddle enough doom-and-gloom about the economy and the financial markets, gold is inevitably suggested as the investment of choice.
Invest $10,000, $20,000, or $50,000 in gold, and once The Crash finally hits, you’ll be an instant millionaire.
You won’t have to do anything else.
The country and the economy may go into a sinkhole, but you’ll be sitting high and dry on your pile of gold.
That’s a fairy tale, not an investment strategy. But it’s a fairy tale with legs, and it’s a recommendation that never seems to get old or go away.
In the interest of balance, let’s take a look at both sides of gold – the case for investing in it, and the case against it.
When you read both sides of the story, I’m sure you’ll agree that gold is over-hyped.
We’ll start with the pro position.
The Case for Investing in Gold
There are several reasons advanced in support of investing in gold.
And as much as I think gold is over-hyped, there is at least some legitimacy to some of these claims.
Gold is a “Safe Haven” Investment
Most asset classes tend to perform well in certain economic conditions, or even in most.
But any investment that’s subject to rising and falling prices is also volatile.
During times of market turbulence or crisis, they may fall in value. Certainly, stocks fall into this category, as does real estate. And even bonds can fall in value during a time of rising interest rates.
It’s during these times – when more traditional assets go into decline cycles – that investors look for safe haven assets. These are asset classes that tend to be either more stable in times of crisis, or even have the potential to rise in value.
Generally speaking, the most popular safe haven asset is US Treasury securities.
Because they’re issued by the US government, and extremely unlikely to default, investors pour money into them during times of uncertainty. In such market conditions, preservation of capital becomes the motivation, and Treasury securities are generally the best way to accomplish that.
But gold is often considered a safe haven investment as well.
It has survived as money for thousands of years and has shown the ability to at least retain purchasing power, come what may.
Gold is less popular as a safe haven because like stocks and real estate, it also has the potential to drop in value.
There have even been times when gold has declined at the same time as stocks and other assets. But gold tends to have its finest performances during times of deep crisis. We’ll get into that point more deeply as we go along.
The Very Long-term Performance of Gold has Been Solid
Gold has an undeniable staying power. As you’ll see when we get to “Gold vs. Stocks” below, it’s returned more than 6,000% in the past 100 years.
Love it or hate it, that kind of return gives gold credibility.
But what’s usually not disclosed in the same advertisements and pitches is that other assets have turned in much better performances over the same space of time.
Gold Can’t be Defaulted On
A common argument in favor of gold ownership is “gold is the only asset that isn’t simultaneously someone else’s liability”. There’s no denying that claim either.
An ounce of gold will always be worth exactly one ounce of gold. It’s just the dollar value that may change.
Most paper assets, including government securities, bonds, and bank assets represent a liability for the issuing agency.
The argument can even be made for stocks since most public companies are a mix of both assets and liabilities, and income and expenses.
Unless you purchase gold using borrowed money, there’s no liability connected to it.
Gold is an Inflation Hedge
It’s also said that 100 years ago (or thereabouts) an ounce of gold bought a good quality men’s suit. At the current price of about $1,200, that’s still true today.
But perhaps a more relevant comparison would be oil versus gold. Back in 1970, oil traded at $3.39 per barrel.
At About $35 an ounce, an ounce of gold would buy a little bit more than 10 barrels of oil.
With oil today at about $72 per barrel, an ounce of gold can buy almost 17 barrels of oil.
So on balance, the claim that gold is an inflation hedge is accurate, at least on a general basis.
Gold Thrives in a Crisis
There’s merit to this claim as well. Gold’s best performances have happened during times of widespread instability.
As we’ll see under “Gold vs. Stocks” below, gold was at its best when stocks were at their worst.
Of course, the flip side to this argument is that gold has historically performed very poorly during times of growth and prosperity.
The Best Ways to Buy and Hold Gold
If you do decide to buy and hold gold, it’s generally best to hold it in its pure form.
There are three primary ways to do this:
1. Gold Coins
The best examples are American Eagle and Canadian Maple Leaf gold coins.
Both are bullion coins minted and issued by each country’s respective government. They’re also two of the most commonly traded gold bullion coins in the world.
They can be purchased through local coin shops, or well-known online gold dealers. Just make sure you investigate the integrity of whoever you’re buying the coins from.
Check with the Better Business Bureau, Yelp and other sources to see if there are any issues with the dealer or broker.
The coins typically trade at premiums of between 5% and 8% over the bullion price of gold. So, if the current bullion price is $1,200, you may pay $1,260, representing a 5% premium.
Coins come in different denominations, from one-tenth of an ounce to one ounce. It’s best to buy one-ounce coins, because the smaller denominations come with higher premiums.
2. Gold Bars
These are pure bullion bars produced by gold fabricators. They are available in sizes from one ounce to 400 ounces, and are purchased through online dealers.
They’re an excellent way to purchased larger quantities of gold, and add a smaller markup than coins.
The disadvantage is that it’s much harder to buy and sell bars than coins, especially larger ones.
3. Gold Exchange Traded Funds (ETFs)
Some gold ETFs actually hold physical gold.
Examples include SPDR Gold Trust ETF (NYSE: GLD) and iShares Gold Trust ETF (NYSE: IAU). Since they’re comprised of gold, it’s a way for investors to invest in gold without taking physical possession of the metal.
It also makes buying and selling as easy as trading stocks. You can buy and sell ETFs on popular investment brokerages for the same commission fees as stocks (in some cases for less than $5 per trade).
Now let’s shift over to the other side of the debate…
The Case Against Investing in Gold
As compelling as the above case for investing in gold might sound, there are more arguments against it. This is why I believe gold is over-hyped.
Gold is Not an “All-weather” Investment
While gold has definitely gone through stretches, including entire decades, where it’s been one of the best-performing assets, it certainly doesn’t perform well in all markets.
In fact, it may go through a few years when it outperforms most other asset classes, but then goes flat or declines for the next 15-20 years.
That even seems to be the normal pattern.
Let’s start with this…
There are a few other things gold doesn’t and can’t do:
- Create useful products and services.
- Innovate new products and services.
- Generate tax revenues.
- Employ workers.
- Improve the environment.
- Make charitable contributions.
- Create a demand for land, buildings, equipment and business services.
In other words, gold is completely inert – or better put – it’s economically neutral.
If you buried it in the backyard it would have no less impact than if you kept it in a safe in your bedroom. Though it does have a certain value, determined by market factors of the time, it doesn’t move society forward in any way.
In that way, it compares more to cash than to actual investments.
Gold Isn’t an Exact Inflation Hedge
Gold has done a good job of keeping up with inflation generally. But what it hasn’t done is track inflation mathematically!
That’s the dirty little secret about gold that you won’t hear from gold promoters. They often cite the performance of gold during the high inflation years of the 1970s. And the facts certainly support that claim.
But gold has not done nearly as well during times of low levels of inflation. Those are actually much more common than times of high inflation. In fact, since World War ll, the 1970s we’re the only time of relatively high inflation. In the other decades before and since, inflation has generally remained well below 5% per year. Gold doesn’t react nearly as well to that kind of low-level inflation, as it does with the more dramatic variety.
In real purchasing power then, gold has declined in the face of a mild level of inflation.
Whenever you hear or read of gold being promoted, this is a side of the inflation story that doesn’t get discussed.
Quite the opposite in fact – gold promoters promise that not just inflation, but hyperinflation is just around the corner. They’ll even point to real world examples, like:
- The 1970s in the US.
- Germany’s hyper-inflation between the two world wars.
- Current examples, like what’s happening in Venezuela right now.
In a way that should make us all suspicious, gold promoters seem to need inflation to make the whole strategy work.
Gold Pays No Interest or Dividends
Remember earlier when I wrote that gold isn’t an investment in income earning business activities? Since gold generates no income, it doesn’t pay interest or dividends to the owner.
Gold advocates may argue this doesn’t matter. After all, the main purpose in owning gold is for the explosion that’s bound to happen when the next Big Crisis hits.
But if you’re a long-term investor, you need to invest in assets that will provide a combination of growth and income. Simply buying an investment because you believe it will go up in price isn’t investing – it’s really speculating. That’s most of what gold is all about.
But since we already know that gold is not a growth type asset, the need to receive some type of income for owning it should seem obvious.
After all, during those stretches when gold isn’t rising in price – which can sometimes go on for decades – the absence of interest or dividends is an obvious disadvantage.
Can you see why interest and dividend income matters? But you won’t get either with gold.
Central Banks can Crush the Gold Price by Selling Their Reserves
According to the World Gold Council there’s about 190,000 tons of gold in existence in the world in all forms, or just over 6 billion ounces. More than 32,000 tons, or nearly a billion ounces are owned by the “official sector”. That’s mostly the central banks of the world.
Here’s the problem with that arrangement from an investment standpoint: since central banks own so much of the world’s gold, they can crush the price by selling relatively small amounts. In fact, just an announcement by a central bank of its intention sell even a modest quantity of gold can cause the price to fall.
For example, in 1999 the Bank of England announced its intention to sell about 10 million ounces of gold (just over 300 tons). Within two-and-a-half months of the announcement of the sale, the price of gold fell from $282 to $252, a decline of more than 10%.
That was a staggering decline based on the sale of just 1% of the world’s central bank gold holdings.
With government budgets and debts being in the trillions of dollars, and close to a billion ounces of gold sitting in central bank vaults earning no interest, the possibility of future government gold sales can never be ignored.
Not all Gold is Investment Quality
One of the complications with investing in gold is answering the question, what exactly is gold?
It shouldn’t be such a complicated question, but it gets that way because gold promoters have different versions of what they consider gold to be.
They often promote products related to gold, that aren’t necessarily gold strictly speaking. But they do it because it generates higher revenue for them.
The problem with these gold knock-offs is they’re the ideal way to own the metal. By buying gold in any of these forms, you increase your risk, without necessarily improving your chances of a big payoff.
Watch out for these alternate forms of gold:
These are coins that trade at premiums over the bullion value of the gold content. For example, a one-ounce coin, containing $1,200 worth of gold bullion, could sell for $4,000. This premium owes to the rarity of the coin itself, and not strictly to the bullion value.
These coins trade at such premiums because there may be very few in circulation. Referred to as numismatic coins, they’re commonly pre-1933 US minted gold coins. 1933 is significant because then president Franklin D. Roosevelt issued executive order 6102 making it illegal for American citizens to own gold.
As a result, the US Government stopped minting common circulation gold coins, and recalled millions of them. That’s created a shortage of pre-1933 coins, and turned them into numismatics.
The problem with buying numismatics is in the price grading. Coins are graded based on their mint state, which is the rarity and purity of a coin according to rating agencies. The higher the mint state, the more valuable the coin.
For example, a coin in mint state 61 (MS61) will be considered semi-numismatic, and command only a small premium over the bullion value. A coin graded as MS65 is much more valuable and will sell at several times the coin’s bullion value.
The problem is that mint state can be subjective. A common situation is where the investor buys a coin graded as MS65 from one dealer, but sells it to another dealer a couple of years later, who judges it to be MS63. The lower grading will make the coin worth thousands of dollars less.
Numismatics have been hawked as investment coins for decades, but they’re really just speculations. They tend to rise in value most during the most extremely bullish gold markets, but even to crash afterwards.
The case for commemorative coins as an investment is even weaker than the one for numismatics.
While numismatic coins do have historic value, due to their rarity, even their consideration as art work, commemorative coins are just gold bullion coins imprinted to commemorate a certain person or event.
You’ll typically see these coins advertised on TV, which should be a warning sign to steer clear by itself. What’s more, they are often minted by non-governmental agencies. For example, a private company may introduce a line of commemorative gold coins representing a deceased celebrity, or even an event like 9-11. But in theory at least, there is no limit on the number of these coins that can be minted.
Since they won’t be rare, they are very unlikely to command premium prices in the future.
Furthermore, many commemorative coins only gold plated. It’s a coin made of cupronickel – which is virtually worthless – and inlaid with gold. To the untrained investor, they can seem like investing in real gold. But to an experience gold investor, they’re close to worthless. You could be paying $100 for a coin that a real investor won’t pay $10 for.
Gold with High Price Mark-ups
One of the complications with buying gold as a small investor is that there are no regulated central exchanges where you can trade.
Most gold coins are purchased through small, independent gold dealers. Many don’t even deal exclusively in gold bullion coins, but primarily sell numismatics, commemoratives, and perhaps even guns or antiques.
The normal premium on gold bullion coins is between 5% and 8% of the bullion value of the coin itself. For example, with a gold bullion priced of $1,200 per ounce, a 5% markup would make the price of a one-once coin $1,260. That’s a reasonable premium.
But there are dealers who will take advantage of unsuspecting buyers. They may charge a 15% markup, in which case you will pay $1,380 for a coin with the bullion value of $1,200. The premium will be $180 over the bullion value.
It’s like buying an investment that loses money immediately upon purchase.
Gold Stocks and Gold Stock Mutual Funds
People who are interested in holding gold often do it by purchasing either gold stocks or gold stock mutual funds.
The advantage is that they’re paper investments that can be easily held in a portfolio, the same way you might include stocks, mutual funds, and ETF’s.
The limitation however is that gold stocks and gold stock mutual funds are not the same is investing in gold bullion itself.
They don’t represent gold, but rather stock of companies that mine gold. That’s completely different from the metal itself, and they also tend to be far more price volatile than the underlying metal.
Better put, gold stocks are more stocks than they are gold. They can be based more on the profitability of the gold mining company than on the price of gold itself. They’re also subject to the stresses of running any business. This includes credit crunches, labor problems, environmental disasters, and bad management. And since much of the world’s gold mining takes place in remote third world countries, they’re also subject to political disturbances and even warfare.
Gold ETFs that Don’t Own any Gold
Some ETFs don’t actually own physical gold, or it represents only a minority of their holdings. Instead, they track the price of gold stocks, or engage in trading gold futures contacts. Either practice makes them either:
A) very risky, and/or
B) not a pure play on gold bullion itself.
In some cases, the value of the fund could fall even though the price of gold rises. If you want to invest in actual gold, these funds are best avoided.
Gold vs. Stocks
When it comes to investment returns, you can’t argue with the numbers.
So let’s take a look at the price performance of gold and the S&P 500 for the past 100 years, as well as shorter time frames. We’ll even include the price performance of both during times of crisis.
100-year performance – 1918 to 2018:
- Gold, price in 1918, $18.99, price in 2018, roughly $1,200 – increase +6,316%.
- S&P 500 in 1918, 7.51, level in 2018, roughly 2,900 – increase +38,615%.
Takeaway: The 100-year performance of both gold and stock favors stocks, and by a ridiculously wide margin.
The Crash of 1929, The Great Depression & World War II: 1929 to 1945:
- Gold, price in 1929, $20.63, price in 1945, roughly $34.71 – increase +68.3%.
- S&P 500 in 1929, 28.49, level in 1945, roughly 14.78 – a decrease of 48.1%.
Takeaway: During the crisis years between 1929 and 1945, gold easily outperformed stocks, and by a very wide margin.
The Post World War ll Prosperity: 1945 to 1970:
- Gold, price in 1945, $34.71, price in 1970, roughly $36.02 – increase +3.8%.
- S&P 500 in 1945, 28.49, level in 1970, roughly 75.72 – increase of +265.7%.
Takeaway: During the 25 years of peace, prosperity, and growth after World War ll, stocks turned in a solid performance, while gold languished.
Inflation, Vietnam & Watergate: 1970 to 1980:
- Gold, price in 1970, $36.05, price in 1980, roughly $615 – increase +1700.6%.
- S&P 500 in 1970, 75.72, level in 1980, roughly 119.8 – increase of +58.2%.
Takeaway: During the tumultuous 1970s, gold left stocks in the dust. And even though stocks did produce a positive return in a difficult decade, they failed to keep up with inflation. According to statistics by the Federal Reserve the Consumer Price Index (CPI) increased from 38.8 in 1970 to 82.4 in 1980, an increase of 212%. With a return of just 58%, stocks turned in a seriously negative performance for the decade.
Prosperity & stability return: 1980 to 2000:
- Gold, price in 1980, $615, price in 2000, roughly $279 – a decrease of 54.6%.
- S&P 500 in 1980, 119.8, level in 2000, roughly 1,473 – increase of +1,230%.
Takeaway: Prosperity and stability are no friends of gold. During these two decades, gold crashed while stocks went out in orbit.
The Dot-com Bust and the Financial Meltdown: 2000 to 2010:
- Gold, price in 2000, $279, price in 2010, roughly $1,224 – an increase of +439%.
- S&P 500 in 2000, 1,473, level in 2010, roughly 1,080 – decrease of 26.7%.
Takeaway: In yet another decade marked by turmoil and economic decline, gold turned in a very strong performance, while stocks turned in a solid loss. The numbers presented above don’t tell the entire story, because the S&P 500 actually hit bottom in 2009, while gold hit its all-time peak in 2011. But the point for the decade is clear.
Prosperity returns: 2010 to the Present:
- Gold, price in 2010, $1,224, price in 2018, roughly $1,200 – decrease of 2%.
- S&P 500 in 2010, 1,080, level in 2018, roughly 2,900 – increase of +268.5%.
Takeaway: In the Absence of turbulence, and in an environment of both low inflation and low-interest rates, stocks have turned an impressive performance in the past 8 years, while gold has flatlined.
Gold vs. Stocks – Analyzing Historic Performance
In analyzing the performance of both stocks and gold, the following points emerge:
1. Stocks outperformed gold over the very long-term. We see that stocks have outperformed gold by a factor of roughly 6:1 over the past 100 years. That doesn’t even account for the dividends paid on stocks, but only the actual price level of the S&P 500 for each given year.
Of course, none of us have an investment time horizon of 100 years. But the long-term trends are what matter most when it comes to investing.
2. Gold has outperformed stocks only the times in the past century. We see gold coming out on top only in 1929 to 1945, 1970 to 1980, and 2000 to 2010. That represents a total of just 36 out of the past 100 years. Stocks have dominated in all of the other time frames, and not just by a little.
Should You Invest in Gold – Or is it a Waste of Time?
I’ve spent a lot of time writing and researching this article, but it’s not because I have anything personal against gold.
What does concern me however, is that people are buying into the hype, and investing large amounts of their hard-earned money into an asset class that goes absolutely nowhere most of the time.
My primary concern, as a financial blogger and financial planner, is to recommend ways for people to grow their wealth. At best, gold is something of a wealth preservation asset. But it is not a growth asset, and will not materially increase your wealth over the long term.
An argument can be made to hold a very small amount of your portfolio in gold – but maybe no more than 5%. That may provide you some protection for your portfolio in the event of another crisis decade, like the 1970s or the early 2000s.
But since stability and prosperity are much more common than times of crisis, your gold investment will mostly sit around and collect dust.
It’s a complete waste of investment money to put a large bet on what is most typically a stagnant asset. While gold is busy running in place, or even declining in value, you’re losing the opportunity to make money in growth type assets, like stocks, and stock mutual funds and ETF’s.
Buy gold if you feel you must, but keep the percentage very low.
And stay with the more basic types of gold, like gold bullion coins and bars, or ETF’s that actually invest primarily in gold bullion.
You’ll do a better job of preserving your capital if you avoid the alternative forms, like numismatic coins and gold mining stocks.
Then make sure most of your portfolio is invested where it should be – in assets that generate income and growth.