Does Gold Really Shine?

Is Gold a Reliable Investment?The uneasy and uncertain global economic environment has spiked investor interest in gold over the past few years. Is gold worthy? Does it really shine?

The past quarter was actually the worst 3 months for gold prices in a dozen years. This has, however, done little to dampen investor interest.  Many investors have created a dialogue about government debt and inflation that says gold is a good “hedge” against uncertainty. Viewed only from the perspective of the past decade, gold has performed well. From a longer time frame, however, gold has not proven to be a reliable investment.

The chart below outlines the inflation adjusted (real) growth in value from 1971-2011.

Gold has the lowest return among the asset classes represented. It is even worse if you exclude the period where gold could not be held directly by U.S. investors in the early 1970’s. From 1975-2011, gold produced a 1.82% real annual return versus 10.6% for U.S. small stocks and 7.1% for the S&P 500.

Is Gold Worth its Weight in a Portfolio?(Click image for larger view)

Most investors believe gold is an excellent “hedge” against rising prices (inflation). The objective is to remove some of the risk associated with inflation. Again, the evidence does not bear this out. When adjusted for inflation, the price of gold from 1980 to 2011 (which includes the big run-up in price over the past decade), has risen just 4%. Not only has gold proven to be an unreliable storehouse of value but it is much more volatile than other assets. If the point of owning gold is to “hedge” against inflation, then it has generally been a very poor investment.

The other often stated reason for owning gold is to function as a portfolio diversifier. To some extent it is true that gold and traditional financial assets (stocks and bonds) perform differently. It is also true, however, that the added volatility of gold offsets much of that diversification benefit.

Finally, all investment positions should contribute to the overall portfolio return within an expected return. Holding physical gold does not meet this test as it provides no income (interest or dividends), only anticipation of possible future gain. From an economic perspective, gold actually has a “cost” in the opportunities that were foregone because of the gold investment.

Over the long term, gold has not provided reliable returns compared to most other assets. The recent positive performance of gold (the past quarter excepted), should not blind investors to the track record over time where gold has had more periods of depreciation than appreciation. The best “hedge” against cost of living increases and overall uncertainty continues to be a globally diversified portfolio.

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