Gold – a Good Investment?

 

A Cautionary Tale

Back in 2011, with the economy not far removed from a major recession, and a nascent understanding that unchecked printing of government money had something to do with it, I made a series of “investments” in gold and silver – including coins, gold/silver pegged mutual funds, and a small IRA.  Needless to say, my timing was immaculate; gold was trading around $1600 an ounce, and silver at $44 (for those who don’t track commodity prices, gold and silver currently trade for $1300 and $15 respectively).

I could end this article right now – and plead with you not to follow in my footsteps. But this cautionary tale is worth a closer look - because the economy again seems ripe for a correction – and the inevitable clamor of “investing in gold” is sure to follow. There is no denying that gold is an asset (an item of significant value) – but is it a good investment?

What is an Investment?

A car salesman may tell you a new Mercedes is a great “investment” in your future, much the same way tooth whitening, gym memberships, etc. may be promoted as a great “investment in yourself”.  But a more precise definition of investment is the process of purchasing an asset - with the expectation of that asset providing income e.g., interest or appreciation in value, in the future.  Gold doesn’t provide a means of future interest payments; if it is an investment, it is only through appreciation (an expectation of a higher future value).

The value of any asset is ultimately based on demand – one that results in a positive cash flow.  In the case of the stock market, we expect that a demand for a company’s goods/services will exceed the cost of providing the goods/services.  With a commodity like gold, we simply expect demand will increase (industrial usages, jewelry, etc.) and/or the supply will drop (e.g., a problem in finding/extracting/refining gold).

Is there a likely change in the future demand for gold – or a problem in the future supply?  Actually, there is.  When the economy starts to tank, demand for gold rises because it is seen as a safe haven and immune from inflation.  But this demand decreases as the economy recovers – and the price of gold tends to revert below and then back to its true market value.

As shown in the figure below, the price of gold has increased by 242% from 1986-2018; this is more than the official inflation* rates measured by the U.S. Government’s Consumer Price Index (CPI-U) - but far below the performance of the S&P 500 (1117%) and Nasdaq Composite Index (2088%).

Figure 1 – Cumulative Percentage Change in Asset Valuation – compared with the Big Mac and the CPI-U Index.

Figure 1 – Cumulative Percentage Change in Asset Valuation – compared with the Big Mac and the CPI-U Index.

Also shown in figure 1 is the BigMac Index; in a prior post, I made the argument it is a more accurate indication of changing prices because the U.S. Government has altered the CPI-U methodology.  If this argument is true, it means two things – 1) the U.S. dollar is depreciating more than is commonly reported, and 2) gold truly maintains its value over the long haul – the BigMac index is effectively the trendline for gold, as shown in figure 2.

Figure 2 – Cumulative Percentage Change in Asset Valuation (including linear trend) compared with the Big Mac Index.

Figure 2 – Cumulative Percentage Change in Asset Valuation (including linear trend) compared with the Big Mac Index.

Closing Thoughts

Over the long haul, gold is a stable asset – and not an investment.  If and when gold is re-established as money, any short-term fluctuations in its value will dampen as well.  Governments will likely never revert to a gold-backed currency, but perhaps the private market will step in to offer a solution.

About the Author

Tyler Chessman is resident of Texas, and the author of the not-so-bestseller Understanding the United States Debt.  He is also the creator of a new gold-backed currency – TxGold.  Learn more at https://Restore.Money.  

*Note that I’m using the term “inflation” as it is commonly used today i.e. rising prices.  Historically, inflation has been understood to be an increase in the money supply – with rising prices being the result of money inflation.

 
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Tyler Chessman