Gold or Stocks: Which is the better inflation hedge?

[Keim]

I hear advertisements for gold all the time. They always say it is beating the market and a great inflation hedge. How good is it? I think I'll take this opportunity to educate myself.

Here is what I found.

In 1980 gold was $850/oz. Gas was $1.25/gallon.
Today gold is $1645.24/oz. Gas is $3.50/gallon.
Gas has nearly tripled. Gold has doubled.

In 1980 the median home price was $76400.
Today a home costs is $155,000.
Looks like gold has held roughly even with housing.

In 1980 a stamp cost .15.
Today a stamp costs .45.
Looks like stamps have out paced gold.

In 1980 bread cost $1.19.
Today bread costs $2.50.
Looks like gold and bread are roughly even.

What is a 1980 dollar worth today? $3.57 (according to inflationdata.com)

How has the stock market done since 1980?
In January 1980 the DOW was at 824. Today it is at 13199. FYI: Before the recession it was at 10959 in 2006.

Bottomline: Gold has done a decent job of staying even with inflation since 1980. The stockmarket has handily outpaced it.

Thats great, Keim. What about a longer timeframe?
The DOW was 100 in 1906.
Gold was $18.90
Gold has increased less than 100 fold since then. The DOW has increased about 130 fold.

Bottomline: Over the last 100 years, a period of enormous upheaval, the Market beat gold hands down. Looks like the market outpaced gold in both short and intermediate terms. I can't find any data from biblical times to compare markets vs gold for longterm. I will concede that gold has proven a better investment for our progenitors than frankincense, myrrh and tulips. I'm willing to gamble we aren't experiencing any epochal events causing gold to seriously outpace the market in the remainder of my lifetime.

 

[ziggy29]

I hear advertisements for gold all the time. They always say it is beating the market and a great inflation hedge. How good is it? I think I'll take this opportunity to educate myself.

Here is what I found....

In 1980...

...

Bottomline: Gold has done a decent job of staying even with inflation since 1980. The stockmarket has handily outpaced it.

I call "data mining" and "cherrypicking start dates" on this one. 1980 happened to be a time when gold was in a bubble and stocks were way undervalued (in a period of very high fear of hyperinflation ahead). If you believe at all in mean-reversion of asset classes, one would expect this situation leading to stocks outperforming gold for a while as both asset classes mean-revert.

Someone making the same case in favor of gold could do the same by starting in 1999, with gold at $290 an ounce and stocks above today's levels (any positive returns would only be because of dividends).

Bottomline: Over the last 100 years, a period of enormous upheaval, the Market beat gold hands down. Looks like the market outpaced gold in both short and intermediate terms. I can't find any data from biblical times to compare markets vs gold for longterm. I will concede that gold has proven a better investment for our progenitors than frankincense, myrrh and tulips. I'm willing to gamble we aren't experiencing any epochal events causing gold to seriously outpace the market in the remainder of my lifetime.

I'm no hard core gold bug here, but I don't think we can include all those years we were on the gold standard in analyzing the future for gold. We should only look at the period since the dollar and gold have been decoupled on the exchange markets.

The better "starting point" for comparison between stocks and gold, IMO, would be 1971 when President Nixon effectively completely abandoned the gold standard and the price of gold was allowed to float relative to the dollar, rather than a dollar essentially being defined as a certain quantity of gold. The Bretton Woods accord of 1944 -- which Nixon abandoned in '71 -- called for the U.S. government to effectively value an ounce of gold at a fixed price of $35. So what was the return on gold from 1944 to 1971? Zero -- from $35 per ounce to $35 per ounce. Inflation beat the pants off of gold.

And I suspect if we "start the clock" in 1971, gold looks better -- not as good as stocks in the long run, but better than either example presented here. I don't trust it for a large portion of my portfolio relative to stocks, but I do like the certain "defensive" characteristics it provides, particularly in tumultuous and inflationary environments.

[Disclaimer: my standard asset allocation includes 6% in precious metal stocks.]

 

[jclarksnakes]

Anyone who mentions tulips in a discussion of investment comparisons deserves an A+ for historical perspective.

 

[EvrClrx311]

< warning - opinions ahead>

Gold is very popular right now... but it is a dangerous "investment"

Historically gold is trading at a high... it is way above its historical average. People who own a lot of gold would like to think "this time is different," but the next 5-10 years will show what history has shown time and time again: what goes up...

It is a lot like the .Com bubble that almost no one saw coming... "this time it's different"... "those P/E values are sustainable because we're living in a new age" sound familiar? "Gold is also different this time"... "the government is going to collapse"... "our monetary system is going down the drain"... "inflation is coming."

Fact is... Gold is overpriced... just like tech stocks were in 1999. Both look(ed) very valuable and like a sure thing near their peaks.

Now that is not to say that Gold isn't a useful tool as a hedge against inflation... it is just a bad time historically to purchase it because its overpriced. Speculation aside, long term (20+ year periods) Gold will rarely be a good investment since it never produces anything... its ultimately just a metal and worth what someone is willing to pay for it (like everything else in this world). Speculating on Golds movement can make you a lot of money... but its just that, speculation. Not a sound investment strategy. You'd be just as "safe" throwing money into Biotechnology index funds that have been returning 20% a year the last few years. Gold popularity is its recent success... as an investment that is never a good reason to "jump in". In fact, getting into the new hot thing is usually one of the worst ways to invest (buy high... sell low).

My advice for those who own Gold thinking it's going to make them a profit... tread carefully. Some own it because they like gold or the want to have a hedge against a disaster like the US currency vanishing... I guess I can buy that (as a small portion of your overall assets, 5% or less). I'm fearful for those people out there who really think Gold is heading to $6,000 an ounce... not happening (at least not in our lifetimes).

Looking at 100+ years of history Gold has always saddled global currency averages and will do nothing other than sit your money in a 0% return after factoring out inflation. Speculation on Gold will allow it to run up or down in shorter periods... like what we're seeing now, but that doesn't mean Gold itself is any more intrinsically valuable than it was 10 years ago. Stocks and Bonds on the other hand produce yields and dividends... companies grow. Gold does not. In fact, gold does the opposite... every ounce of gold that was every mined in human history is still in circulation today. There are billions of ounces yet to be mined from the sea/ground... there will ALWAYS be new gold entering circulation, but never any Gold leaving it.

If I did own any gold today that I purchased years ago... I'd take my profits while I could. If I just bought gold... I'd sell it - too risky right now with how insanely high it is sitting.

 

[Keim]

As Ziggy29 points out, gold was unusually high that year. I wasn't attempting to cherry pick (honest!). It does appear the price settled at closer to $500/oz a few years later.

1980 must've been a bubble. Aren't we likely to be in one of those again right now?

 

[ziggy29]

1980 must've been a bubble. Aren't we likely to be in one of those again right now?

Smells like one to me. There's no way I'd establish a new, large position now. I am happy, however, to sell a little more each year as the price rises so I can buy other stuff that's cheaper, like all the gold shares I sold in 2008 and 2009 to buy equities. I still have about 6% of my portfolio in precious metals stocks as I have when I set that allocation in 2004, but I've probably sold about 60% of the shares since then to buy other stuff that less overvalued. So even if what I do have left tanks in value, I've still come out way ahead with rebalancing.

 

[Keim]

I
And I suspect if we "start the clock" in 1971, gold looks better -- not as good as stocks in the long run, but better than either example presented here. I don't trust it for a large portion of my portfolio relative to stocks, but I do like the certain "defensive" characteristics it provides, particularly in tumultuous and inflationary environments.

[Disclaimer: my standard asset allocation includes 6% in precious metal stocks.]

Lets see what the numbers say.

DOW in 12/71 was 891. 13199 now.
Gold in 71 was 40.62. ($154 by 1974!) $1645.24 now.

Gold has increased 40 fold since 1971. 10.6 fold since 1974.
The DOW has increased 14.8 fold since 1971.

Interesting. Wonder what it'll look like when the gold bubble pops. Based on these numbers gold appears to be a smart choice for part of an asset mixture. Don't think I'd bet the bank on it though.

ETA: I also have a small percent of my portfolio in VGPMX. Too bad I only got in it last year!

 

[MichaelB]

Are we talking about hedges or investments? Over time stocks are the better investment because the underlying businesses generate added value. Stocks do poorly when inflation rises unexpectedly but then catch up once inflation stabilizes. Dividends also tend to increase over time at a rate greater than inflation.

The has been a lot written about collateralized commodity index funds (CCFs) and there are some very interesting debates (a few years back) between Larry Swedroe and Rick Ferri on that over at Bogleheads and Morningstar forums.

GMO says timber land is a superior investment for inflationary times, but the opportunities are limited.

 

[ziggy29]

DOW in 12/71 was 891. 13199 now.
Gold in 71 was 40.62. ($154 by 1974!) $1645.24 now.

To be fair, before Nixon put the final nail in the coffin of the gold standard, the price of gold was probably artificially low because of the peg to the dollar, hence its quick pop in value immediately thereafter.

 

[braumeister]

Historically gold is trading at a high... it is way above its historical average.

But well below its inflation-adjusted historical high.

 

[EvrClrx311]

Interesting factoid... (changes by a small order of magnitude based on what study you read)

there are approximately 50-500 billion ounces of Gold floating in the worlds oceans... or roughly 38 pounds of gold per cubic mile. It would not be cost effective today to "mine" this gold... but if a future technology allowed millions of self replicating nano-robots to collect these particles of gold... it would dwarf today's current circulation by a factor of 10 to 100. There would suddenly be 10-100 ounces of gold out there for every human on earth... instead of just 1 ounce like we see today.

Factor in how much gold still exists in the ground and what we as humans have accumulated in gold is only a small fraction (well less than 1%) of what actually exists on earth.

Evidence suggests that hundreds or thousands of asteroids contain gold, many with more than the entire earth has in circulation today. Kind of puts the whole "gold is just a metal" in perspective. What happens if a day comes when Gold isn't so rare?

 

[EvrClrx311]

But well below its inflation-adjusted historical high.

true... I think for the very short term - gold is ok. Inflation is still a risk. Once we get through this rut we're in... Gold is going to drop pretty drastically. My prediction is that within the next 5-10 years we'll see Gold back at $500-800 (in today's dollars).

I'll probably buy some then

 

[NYEXPAT]

Not promoting anything, but whenever I see somebody quoting long term results in regards to the stocks, I have to wonder what the yields would have looked like if someone in 1928 (when the Dow 30 was created)had invested an equal amount in each of the 30 companies and held it till now?

Allied Chemical

American Can

American Smelting

American Sugar

American Tobacco B

Atlantic Refining

Bethlehem Steel

Chrysler

General Electric Company

General Motors Corporation

General Railway Signal

Goodrich

International Harvester

International Nickel

Mack Truck

Nash Motors

North American

Paramount Publix

Postum Incorporated

Radio Corporation

Sears Roebuck & Company

Standard Oil (N.J.)

Texas Company

Texas Gulf Sulphur

Union Carbide

U.S. Steel

Victor Talking Machine

Westinghouse Electric

Woolworth

Wright Aeronautical

 

[Keim]

I don't have the wherewithal to investigate each stock. But, if one had the ability to invest in an index fund it would look like this: DOW on 10/1928 was 240. 13199 today. A 55 fold increase.

Wish I had a time machine to go back and invest on 7/32. DOW was 43.79. A nasty fall in a short term. A 301 fold increase when compared to today!

Not promoting anything, but whenever I see somebody quoting long term results in regards to the stocks, I have to wonder what the yields would have looked like if someone in 1928 (when the Dow 30 was created)had invested an equal amount in each of the 30 companies and held it till now?

Allied Chemical

American Can

American Smelting

American Sugar

American Tobacco B

Atlantic Refining

Bethlehem Steel

Chrysler

General Electric Company

General Motors Corporation

General Railway Signal

Goodrich

International Harvester

International Nickel

Mack Truck

Nash Motors

North American

Paramount Publix

Postum Incorporated

Radio Corporation

Sears Roebuck & Company

Standard Oil (N.J.)

Texas Company

Texas Gulf Sulphur

Union Carbide

U.S. Steel

Victor Talking Machine

Westinghouse Electric

Woolworth

Wright Aeronautical

 

[clifp]

That is a fair point that there is a good amount of survivor bias in the Dow and other indexes. Still I think the guy who bought the 30 original Dow Stock back in 1928, and did no other transaction for the rest of his life would have a return (primarily due to dividends and the big winners like GE, Standard Oil (Exxon)) that would great exceed the increase of gold from $28/oz back in 1928.

 

[ziggy29]

Wish I had a time machine to go back and invest on 7/32. DOW was 43.79. A nasty fall in a short term. A 301 fold increase when compared to today!

Yeah, that 1932 low itself was based off an 89% decline (!!!!) from the 1929 highs.

It remains to be seen whether the crash levels of the market in March 2009 were this cycle's mini-equivalent of 1932, but I will at least go on record as saying "I hope so." Don't need to experience that wild ride again any time soon (or ever)...

 

[EvrClrx311]

Someone who bought $10,000 in GE in 1962 would be worth $1,237,500 today...

I don't have the data back to 1929... but extrapolating that 10% a year return back to 1929... you'd have to assume that $10,000 invested in just GE would be worth a little over $27,000,000 today.

Or $100 in GE stock then would have grown to $270,000 today (83 years later)

 

[Keim]

Gold has increased 58 fold since 1928, Clifp. A pretty close match to DOW 1928, easily surpassed by someone that got in during the depression.

Lesson: By stocks in depressions. Gold when stocks are highly valued. IE Buy on the dips-duh! (duh aimed at self, not others.)

 

[Gone4Good]

1980 must've been a bubble. Aren't we likely to be in one of those again right now?

Who knows. But we do know this:

• Gold has just finished a 10 year bull run that has returned CAGR of 19%
• The oz of gold people are buying today is identical to the oz of gold people bought 10 years ago at 1/6 the price and identical to the one they'll want to sell 10 years forward
• Gold generates no cash flow
• There is no fundamental way to value gold, so nobody really knows what it is worth or what it should trade for

Good luck

 

[EvrClrx311]

Gold has increased 58 fold since 1928, Clifp. A pretty close match to DOW 1928, easily surpassed by someone that got in during the depression.

Lesson: By stocks in depressions. Gold when stocks are highly valued. IE Buy on the dips-duh! (duh aimed at self, not others.)

this is why in Feb/Mar of 2009... I took every penny I had in cash and invested in stocks... talk about a once in a lifetime opportunity to make a quick return on your cash holdings.

 

[braumeister]

true... I think for the very short term - gold is ok. Inflation is still a risk. Once we get through this rut we're in... Gold is going to drop pretty drastically. My prediction is that within the next 5-10 years we'll see Gold back at $500-800 (in today's dollars).

I'll probably buy some then

Sorry, but you're totally out of step with pretty much everyone in the financial community these days.

"Short term" refers to the period between now and tomorrow morning.

"Medium term" means next quarter.

"Long term means two or three quarters out.

 

[MichaelB]

"Short term" refers to the time it takes for the first beer to reach the stomach on a hot day.

"Medium term" means the next beer.

"Long term' means you can finally settle back in your chair and take your time while you enjoy one.

fify

 

[Keim]

Just saw this series of charts: Fred's Intelligent Bear Site - Dow-Gold Ratio

They purport to be a chart of the DOW divided by the price of gold over the years. Interesting, but I'm not sure if it shows anything the previous numbers I looked at don't also show.

 

[ziggy29]

Just saw this series of charts: Fred's Intelligent Bear Site - Dow-Gold Ratio

They purport to be a chart of the DOW divided by the price of gold over the years. Interesting, but I'm not sure if it shows anything the previous numbers I looked at don't also show.

From the link:

The Dow/Gold Ratio chart shows that we have witnessed the end of an era for equities. Stocks had an 18 year bull market where buy and hold was the guaranteed way to make money. Unfortunately for the stock market bulls, asset classes go in and out of favor, and gold has proven to be the next great asset class. The chart shows that it would be logical to expect the ratio to return to at least a value around 5. Perhaps a ratio of 5 would be gold 2000, Dow 10,000. How far down the ratio goes after that is completely dependent on government policy. Zero interest rates coupled with huge government deficits could send the Dow/Gold ratio far below 5.

WOOT! We have our "Death of Equities" sighting for this market cycle!

 

[EvrClrx311]

Sorry, but you're totally out of step with pretty much everyone in the financial community these days.

"Short term" refers to the period between now and tomorrow morning.

"Medium term" means next quarter.

"Long term means two or three quarters out.

No offense taken, guess its all relative... for me, with investing

Long Term: till SS gets here (35 years)
"money I need to last as long as me"

Mid Term: till my house is paid off (10-15 years hopefully)
"money I need to get to ER"

Short Term: that dang tax I get hit with when selling a stock within a year
"money I don't really care about... unless it makes me more money"