You can hardly watch television for five minutes these days without seeing an advertisement extolling the virtues of buying gold. The precious metal is often seen as a safe-haven from economic downturns, but the reasoning for that argument is basically because it is a widely held belief. Like cash without the erosion of inflation, gold ownership is thought to be a way to store economic value.
On the other hand, gold has few industrial uses beyond its use in jewelry. Jewelry purchases, and more generally discretionary spending, tends to slow in recessionary times. The same can be said of industrial production. This makes it difficult to understand why gold prices increase as economies slow.
Among other disadvantages of owning gold are storage and security costs. The aforementioned wide acceptance of its worth also makes gold susceptible to theft. Once stolen, gold is difficult to identify by its rightful owner since it can be transformed to remove identifying marks. The biggest disadvantage in gold ownership, relative to other investments, is its lack of cash flow. Like other commodities, gold has no earnings beyond price appreciation and pays no dividend without relinquishing ownership. This makes it difficult to determine what gold is truly worth. You are left purchasing based on the idea you will find someone willing to pay more than you did when you are ready to sell, a concept referred to as "the bigger fool" theory in financial circles. This is not the basis for an investment in my mind, but a speculation on the rising price of an almost useless commodity.
In current times it is easy to see how an investor could be attracted to gold. The tables below show gold outperforming stocks and inflation by a wide margin over the past 10 years. However, in observing all other longer period returns, you see stocks have more than doubled the price growth of gold in the 20- and 30-year periods measured by annualized percentage and significantly outperformed in the 40-year period. The annualized returns may be deceptive to one not accustomed to the impact of compounding of returns. The annualized return on the Dow Jones Industrial Average in the 40-year period seems a meager 2% better than that of gold; however, the dollar return difference is more than double that of the shiny metal. Much of that difference can be attributed to the dividends paid on stocks. The current dividend paid on Dow Industrial stocks is 2.92% on average with the longer-term average being closer to 2%.
A theoretical $1,000 investment would have grown to:
| Asset |
40 Years |
30 Years |
20 Years |
10 Years |
| Gold |
$23,050 |
$3,017 |
$2,643 |
$3,717 |
| Dow |
$47,105 |
$28,320 |
$5,687 |
$1,097 |
| Inflation |
$5,839 |
$2,923 |
$1,731 |
$1,289 |
| Returns as of 8/31/09 |
The percentages (annualized):
| Asset |
40 Years |
30 Years |
20 Years |
10 Years |
| Gold |
8.16% |
3.75% |
4.98% |
14.03% |
| Dow |
10.11% |
11.79% |
9.08% |
0.93% |
| Inflation |
4.51% |
3.64% |
2.78% |
2.57% |
| Returns as of 8/31/09 |
I know companies have changed, becoming more efficient. Information is dispersed more quickly and efficiently. However, the same inter-related economic factors remain in effect today as have been for at least the past 40 years. On that basis, I believe the long-term performance of all of the assets presented here are likely to hold over the coming long term. I would be cautious of an investment in an asset that has significantly outperformed its average over the past 10 years, especially without any clear explanation of the fundamental drivers of its growth. This brings us again to the problem of timing. When do I buy? When do I sell? Where gold is concerned, all we have to look at for an indication of tomorrow's price is yesterday. Gold currently trades near its all-time high price.
One final thought: Have you ever stopped to consider the intentions of the television advertisement? The individual pumping you to buy gold, the industry professional, is willing to sell you his gold.
If you have additional questions or would like more information on commodities, contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.
