Situation: The global economy is talking about recession. Unemployment is too high. GDP growth is miserable and fear of rising inflation is widespread. The price of gold is skyrocketing. You are now thinking: Should I buy gold? It is a safe investment right? A store of value in uncertain economic times. A safe haven that will let me sleep easier at night.
I am describing the current economic crisis, am I not? Actually, I am describing 1979-1980, the couple years leading into a severe global recession (or double-dip recession depending how you see it). This is a recession that the economy would not fully recover from for 3 to 4 years.
The economy of the late 70's and early 80's is eerily similar to the previous 3 years in the US starting in late 2008, with the exception that interest rates remain at record lows and inflation has been tame. Perhaps we can glean something from the familiar past as to the performance and safety of a gold investment in such an environment.
I will even give the gold bugs the leg up and say they were so on top of market trends in the late 70's that they put all their money into gold at near optimal timing. For my analysis, I assumed someone invested in gold at the end of 1978 at $208/oz. Just prior gold’s run up to its highest inflation adjusted price of all time, somewhere north of $2500/oz ($850/oz in nominal terms).
How did such a prescient investment work out?
The results may surprise you. The graph below compares that investment to the same investment in the S&P 500 assuming all dividends are reinvested. It assumes the S&P ends 2011 down 5% from 2010 and that gold ends 2011 at $1800/oz.
So the answer to the question is: the gold investment performed very poorly on a relative basis. The $1 invested in the S&P has grown to $31.92 at the end of 2011 while the investment in gold has grown to a mere $8.65. The S&P returned 4.3% higher on an annualized basis. The gold bugs from the 1980's are probably not feeling great about the "store of value" that gold provides nor do they care at all that gold is a "safe bet" because it is considered "currency." Especially the ones that bought gold at its all time inflation adjusted high in 1980. They still have not broken even.
So let me ask: The year is 2011. The global economy is talking about recession. Unemployment is too high. GDP growth is miserable and fear of rising inflation is widespread. The price of gold is skyrocketing.
Are you going to buy gold?
wow Burk, that graph is pretty compelling! I've kinda thought of gold lately as a place to "park funds" that won't see as much volatility while all this craziness is going on. My investments guy told me that he recommends having 10% gold in a portfolio as a hedge in case the market just absolutely goes to crud and you actually do need it as a currency, but he also noted that if it gets bad enough to where you need to have the gold you have invested in, you better carry around a weapon as well because you will need to protect yourself because it will be pretty nuts!
ReplyDeleteIt is certainly true that stocks have had a good run; at the end of 1978 the S&P 500 was under 100 and now it is over 1,200.
ReplyDeleteBut since Nixon closed the gold window in 1971 (while foreign governments were lined up to get our gold at $35 per oz), gold has gone up by a multiple of 50. Is it possible that the life span of all the fiat currencies is near an end and that gold will go up by another multiple of 50? Or a multiple of 100?
What if China (or the oil producing countries) suddenly refused to accept any more constantly depreciating paper dollars and demanded gold? Would the world suddenly be back on the gold standard? At, say, $250,000 per oz? Or $500,000 per oz?
The World Gold Council says that the total stock of above ground gold is only 165,600 tonnes or about 5.3 billion oz. If the world does go back on the gold standard, it has to be at a very high dollar amount per oz to support the level of commerce we have today.
I bought gold today, September 15, 2011. The upside for gold in the next few years - given the world-wide financial turmoil - looks like a lot more than the downside. How much might I lose? 50%? How much might I gain? 5,000%?
Jon Gutek, JD/CPA
www.TheRealTruthAboutMoney.blogspot.com
Jon is right, why don't you take that chart back to 1971 levels for gold and S&P. I also see nearterm gold rallies as the BRICS and other developing countries transform from exporters to consumer/importers . They won't be buying from US or EUROzone, and they won't need USD or its ridiculously low return
ReplyDelete@ Josh and Jon
ReplyDeleteMy analysis was an attempt to compare the current situation to a previous situation that shared many common aspects in order to possibly learn something about the direction of Gold and Stocks in the future.
1971 is cherry picking data which has no relation to the current market. I could say. What about the S&P 500 vs Gold return from 1950 to 1971? But that is not relevant to the current time period.
1971 was hardly a normal situation and bares no similarity to today. The only way 1971 could be used as a comparison is if we were currently on the Gold Standard. 1971 was in no way a "normal" time to compare the current gold performance to.
There can be arguments for holding gold, although I don't, and will not hold gold based on research instead of speculation. Inflation was very bad in the 1970's and Gold still plummeted spectacularly for the next 30 years.
The point is that gold is in no way a safe haven as everyone seems to believe. It is very speculative and is ultimately a ponzi scheme. It is only worth what the next person is willing to buy it for. Even if that next person is a government. If governments decided to go to a silver standard (which has existed before) because gold is too rare to support the current world economy, then you would immediately see a free fall in gold prices.
And this relates to Jon's comment. No way the government would ever pay you $500,000/oz for gold. Even if we went to a gold standard they would probably confiscate it from you at a fixed price. And the fact that there is only 165,600 tonnes above ground is another reason some other metal or commodity currency makes more sense to use given the current world economy size.
Certainly interesting analysis when assuming that historic patterns can be used to predict the future. Unfortunately, history itself has often proved this hipothesis wrong. In 1979 the world was in the midst of the cold war and the US dollar's value was still perceived as solid as gold. Today's world is much different than 1979 and hence, the market's answers to today's challenges will probably be a different one as well.
ReplyDelete@ Anonymous...
ReplyDeleteand today we are not in a war and people are not flocking to the dollar?
You must be referring the same quote my history professor used to tell us in school "History never repeats itself..." or do I have that wrong?
Eric: I like the quote at the top of this page but I am not sure that I understand it. Is a valid paraphrase "we can't all get rich doing the same thing"?
ReplyDeleteForget stocks and forget gold. The U.S. I bond available at your local bank with no transaction fees and built-in tax deferral is paying 4.6%.
ReplyDelete