GOLD RUSH!

Well folks, Gold has finally done it.  It has attained a hallmark of many asset bubbles.  Gold has gone parabolic.

Additionally, GLD, the most popular gold ETF, just surpassed SPY (which tracks the S&P 500) as the largest ETF, as measured by net assets.

This provides a great time to reflect on gold's value as an investment and the contemporary arguments for gold investing.

The latest gold rally picked up steam in the middle of the last decade.  The trend picked up in popularity as stocks began to stumble in 2007-8.  The primary argument for gold at this point was that inflation was on its way, and gold is an excellent hedge for inflation.  Setting aside the fact that no other assets were indicating high inflation, we should ask, is gold really a good hedge for inflation?  The answer is that it has not been for the last 25 years.  In fact, gold is still 25% away from it's inflation-adjusted high... which was set 30 years ago.  So in real (inflation adjusted) terms, gold has lost value. 

Of course, that statistic cherry picks the start date as the excessive highs of 1980, but gold has had a very low correlation with inflation since.  Look at the most recent rally.  Gold has nearly tripled in value, but we have been in a period of rather modest inflation.  We can also go back and look at the entire 1990s.  The decade was an economic boom.  Stocks quadrupled in value.  Inflation was up over 30%.  What happened to gold prices?  They lost value.  They didn't keep up with stocks, and failed to even maintain their purchasing power.  The relation between gold prices and inflation is tenuous.

If I wanted to hedge for inflation, I would simply invest in short term Treasury Bills, which not only do a great job of keeping up with inflation, but outperform stocks and bonds in high inflationary environments.  Or, if I were determined to hedge with commodities, I would focus on those commodities whose prices actually work their way into inflation, such as oil, food, and metals which have industrial utility, such as copper.  Or, I could just stick with stocks, which, unlike gold, have compensated me for inflation over the past 30 years.

Inflation aside, the reason du jour for investing is gold is that it is a "currency" with no government around to erode its value.  This is certainly true, as central banks cannot yet print gold.  It is conversely true, however, that there is no gold-based economy to strengthen it's value.  At least in Tallahassee, grocery stores just will not accept doubloons.  Ignoring the fact that currency values are relative, if interest rates rise and economies recover, currencies strengthen, but there is no similar argument for gold.  The currency based gold trade is reliant on weak global economies and continued devaluation of major currencies.  However, the need and political will for economic stimulus is waning.  According to this argument, gold's rally is over once recovery begins.  Additionally, there is very little cementing gold's place as the alternative currency.  Should investors decide to abandon gold in favor of sea-shells or rai stones, there is little from stopping them. 

The aspect of the gold hype that bothers me is the disregard for risk.  Gold has been among the strongest performing assets over the past 5 years, and too often that is misinterpreted as being one of the safest assets.  Gold is a risky asset.  In the aftermath of the 1980 gold bubble, gold lost over 65% of its value.  Some perspective for those investors who have been roiled by stocks lately:  stocks lost less than 60% during the financial crisis.  You only need to go back to 2008 to find the last time that gold lost over 20%.  Gold can be just as risky as stocks, perhaps even riskier.  The more modest gold pushers argue that there is a place for gold in every portfolio.   Of course, there is no asset suitable for every portfolio, and worryingly this is the same case being made for oil in 2008 as it climbed near $150/barrel (and before it collapsed below $40).

Personally, I don't invest in gold, largely because I just don't understand it.  In addition to the above points, I don't invest in gold because it doesn't do anything for me.  Gold doesn't pay me a dividend.  Gold doesn't innovate.  If gold is underperforming I cannot replace the management.  Gold doesn't adapt to new markets.  The developing world is not depleting our gold supplies.  The emerging Asian middle class is not eating more and more gold. In fact, I have to pay someone to store my gold for me!  The gold story just does not leave me very fulfilled.

*No information in this commentary is meant to be taken as investment advice. Please contact your financial advisor before making any investment related decisions to be sure they are suitable to your needs, goals and risk tolerance.