The Case Against Gold

7/31/2019 The Case Against Gold

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THE CASE AGAINST GOLD

By: Frank Armstrong, CFP, AIF

Two thousand years ago, a Roman senator could buy a reallyspiffy, top-of-the-line toga for about the equivalent of one ounceof gold. The Armani family would hand-tailor his garment fromthe finest imported fabrics and most stylish dyes--a real powersuit, guaranteed to turn heads while sending a strong message ofrestrained power and worldly sophistication.

During the Civil War, a fashionable man's suit cost about thesame as an ounce of gold. Today, with an ounce of gold hoveringat about the $300 level, careful shopping will buy you a fair off-the-rack suit at a chain department store, but the Armanis won'tlet you in the store for just the price of an ounce of gold.

Using this highly anecdotal "evidence" I conclude that even long -term investors have not experienced significant appreciation fromholding gold. Yet there is a small but committed cadre of "gold

bugs" that hold the metal in almost mystical reverence as theultimate store of value. Their endlessly repeated mantra thatevery investor should hold 10% to 20% of his or her assets ingold hasn't changed a note in my lifetime. What can be behindgold's emotional appeal, and how did it get such a lock on ourcollective consciousness?

The Glitter of Gold

Gold has been known and treasured for more than 3,000 years inboth the New World and Old. It's easily worked into elaboratedesigns, almost indestructible, and beautifully lustrous. But whenKing Croesus of Lydia issued the first gold coins in 560 B.C., goldbecame money. The two have been linked ever since.
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As a medium of exchange, gold had a lot going for it. It's scarce.All the world's gold would fit into a cube only 60 feet on eachside. Production is limited, and output cannot be increased rapidlyor inexpensively. Gold is easily concealed, durable, and portable.

A family could hide their wealth by burying it in the ground. Itwon't rust or decay, and could remain safely hidden away fromboth the tax collectors and thieves. (A fair amount of the world'sgold has been lost as owners die off without revealing their hidingplace to their heirs.) If your clan, tribe, religion, or family wasliable to come under occasional attack, you could carry yourwealth with you if you were fortunate enough to escape. Finally,unlike printed money, it's hard to counterfeit, and thegovernment can't just make more when the time is not

convenient to balance the budget. So, it's easy to see how, overthe centuries, gold became the accepted proxy for wealth,security, and permanence.

Gold Bugs and Bears

However, in today's world, an offshore investment account and acredit/debit card may perform many of gold's previous functionsmuch more effectively and conveniently. If you are concerned

about your country's inflation rate, you can always buy assetsdenominated in another currency through your Cayman IslandTrust. If you think you may have to beat a hasty retreat from anunfriendly government, you can send assets via wire to a safe,friendly island in the sun. It's so much easier than sewing it inyour suit coat lining or loading up the submarine with thoseheavy gold bars.

Owning gold bars as a financial asset is inconvenient compared

with the modern alternatives. Bars must be stored, protected,and insured. They earn no dividends, and while they may act asan inflation hedge, they haven't produced any real growth.

Few mutual funds actually own bullion. As you would expect,those funds closely track the price of gold. Other "gold" funds
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own gold-mining stocks. The mining-company stocks are greatlyinfluenced by the price of gold, but other factors influence theirperformance. The companies are a for-profit business subject toall the normal business risks. For a mining operation, it's possible

to find more gold, have the existing mines peter out, pay morefor labor, or lower costs because of better technology. Anincrease in the price of gold won't do you much good if you havecome to the end of your vein. It's also possible that the next rockyou turn over may reveal riches beyond your wildest dreams.Gold-mining stocks tend to be much more volatile than the metalitself, due to the financial leverage of the operating companies.

While there is stable industrial, dental, and jewelry demand for

gold, the market is subject to enormous political risk. Ifgovernments sell gold, bad things happen to the world marketprice. It shouldn't be a big surprise that the gold companies havea marketing association, complete with a propaganda arm thatincludes a public relations staff and lobbyists. High on their list ofconcerns is legislation aimed to keep gold as a central bankreserve backing the world's currencies. Right now they are busyreminding Europe of the benefits of having the ECU linked togold. There are ongoing efforts to prevent central banks from

dumping their gold on the market to raise cash or balance thebudgets. Funny how the gold producers seem much more keenon the problem than most economists or central bankers.

Of course, the gold producers are anxious that you not forget thelong-term benefits of owning gold as an investment. Theirliterature is full of references to stability, inflation hedges, andthe perils of owning "paper." They are quick to note that goldactually rose in value during the crash of 1987; however, they

are somewhat slower to point out that U.S. Treasury bills didbetter! Much is made of the low correlation to other asset classesand the gold-bug creed that everyone should devote 10% to 20%of their portfolio to gold as a hedge against economic collapse.

Gold Has Been A Wild Ride....


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As this graph of gold spot prices from March 1988 through March1998 shows, gold prices have zigged and zagged vertiginously,while trending mostly downward in price.Source Bloomberg.

On the whole, gold stocks are extremely volatile. Afterburnerclimbs are often followed by kamikaze dives. It's not unusual tosee gold at both the top of the funds list for the current quarterand at the bottom of the list for the trailing 12 months. Theaverage precious-metals fund has a standard deviation of 26.5over the past 10 years, compared with the domestic-equity fund'saverage of 15.6. It's hard to think of another asset class withsuch high risk--and such disappointing returns.

...But It Hasn't Paid Off

1 yr ret 3 yr ret 5 yr ret 10 yr ret

Wilshire 5000 Index 47.74 31.14 21.27 18.13

JSE Gold Index -45.14 -26.74 -15.77 -12.28


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While the overall stock market, as reflected in the Wilshire 5000index, has soared over the past decade, gold has been aperennially losing investment. Source: Morningstar Principia.

It's not enough to build the case for an asset class on its lowcorrelation to other asset classes. The chance to lose moneywhile every other asset class on the planet is making money isnot an appropriate rationale. Each asset class should also havepositive expectations, and risk levels appropriate to the expectedrates of return. In other words, I don't see any point in an assetthat won't pull its weight by generating real positive returns overthe long haul. Gold may occasionally dazzle, but it flunks the test.

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The Case Against Gold