Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Thursday, February 10, 2011

Is gold a good store of value?

I know I'm asking for trouble here. Goodness, simply mention the yellow stuff and people go crazy. In an earlier post, I asked Is Gold Money? I answered "no." To all those who were deeply wounded by this answer, I am truly sorry. But the answer is still "no."

Of course, the answer depends in part on how "money" is defined. There are legal definitions, like "lawful tender" and "legal tender" (they are distinct). There are operational definitions, like M1 and M2. But the definition I used was an economic one. Money is an object that "circulates widely as a means of payment." In the U.S. today, cash fits this description. So do the electronic digits sitting in your chequing account (so M1 fits).

But gold, in whatever form it takes, does not fit this description. Unlike government cash and bank digits verifiable by debit card, there is no standardized easily recognizable gold unit circulating widely as a payment instrument in the U.S. today. If you were to try to pay your groceries with gold coins, they might accept them, but at a huge discount. This discount reflects the illiquidity of gold. Gold is not money.

This is not to say that one should therefore not own gold. Even if gold is not money now, it may be one day in the future. And even if it is never money, it may still constitute a good store of value. Certainly, gold appears to be a better store of value than, say, the USD. The price of gold, measured in units of USD, has been rising over time. The purchasing power of the USD has been falling over time (inflation).  So gold is a better store of value than the USD.

But so what? Who in their right mind stores value by tucking USD under their pillow? Cash is easily transformed into an interest-bearing asset, like a government or corporate bond. Or one could purchase a wide basket of equities, like the S&P500. The question I want to ask here is whether gold is a better store of value than one of these competing storage devices.

In what follows, I choose the S&P500 total return index (assumes that dividends are re-invested). The experiment is as follows. I am going to take four years: 1970, 1980, 1990, and 2000. For each of these years, I am going to imagine investing $1 in gold and $1 in the stock market. Then I'm going to track how well these two investments store value from the starting date to the present.

Returns since 2000

If you had invested $1 in gold in 2000, you would now be up almost 500%. In contrast, your investment in the S&P500 would have returned virtually zero. Gold appears to have an excellent store of value over the last decade.

Gold is frequently touted as a superior inflation hedge. Yet, the US inflation rate over the last decade was not very high. Nevertheless, gold kicked a$$, so to speak. Good for gold. Good for gold bugs.

Returns since 1990

Whoa, this looks a little different, don't it? If you had invested $1 in gold 20 years ago, you would have gone 15 years with negative to zero returns. A late sample rally makes your return look a little better, but over this longer sample period, the S&P500 kicks gold's a$$. But maybe we just have to look at a longer time horizon...

Returns since 1980

Oh, gosh. That didn't work, did it? In fact, over 30 years, the relative return on gold looks absolutely horrible. Well, at least the return looks more stable, if that's any consolation.

Return since 1970

Alright, we knew things had to get better for gold--and they did. The 1970s, a high-inflation episode, was a terrible decade for stocks and a very good one for gold. And it is the memory of this decade that remains burned in a gold bug's brain.

And it's a good lesson to have burned into one's brain. It probably justifies holding some gold in a diversified portfolio of wealth. Can't help but note, however, that even allowing for the disaster that was the 70s, the stock market still outperformed gold in the long-run. Something to keep in mind.


  1. I completely agree gold is not money....well it is in a mad-max world. Gold is money in a world where you need the "option" to melt a coin and use the material to gain value for trade.

    As for gold as an investment, well, I'd like you to perform the same analysis of investing in 1 year CD's since the inception of the Federal reserve bank. And compare that to the previous 100 years.

    If you do, you could make a case that US cash used to be a great investment, until dollar devaluation picked up.

    General point is, nothing over 100 years is truly a blanket statement is a safe investment. Look at Detroit real estate in 1950's and now. Buy as many houses as you want for 5k a pop now. In this global, dynamic world, everything is a potential good store of wealth for a period of time. But nothing is absolutely a good investment over the duration of life.

    While I agree gold is a horrible storage of wealth for peaceful times, it may be a good storage of wealth in a period of political turmoil. For after all, all currencies are fiat, and in times of crisis people run to what they know. And I expect the herd to run to gold. In the end, it's just another ponzi scheme.

  2. Admin, feel free to delete this post if you deem inappropriate. I posted my spin on good investment for next 30 years "in general". Covers, cash, gold, etc. I also link to another article I wrote on the next currency the world needs.

  3. Whether gold (or stocks) will be a good store of value in the future cannot be known from how good a store of value it was in the past.


    So if you can predict events that will cause gold to go way up, buy gold, and if you can predict reasons that will cause gold to go way down, sell gold, and if you can't predict stuff about the future, just diversify your portfolio and don't try to pick asset classes.

  4. Is the storage cost included in the gold price series you use? It is neither cheap nor riskless to store substantial amounts of gold. Over the long run, this cost would dominate.

  5. ds

    I think your comment is the reason why most all of those who love gold also love guns. The more gold you buy the more guns you need to keep other folks from stealing it.

  6. One word has been left out here, "confidence" -supreme, and gold has little value, lacking altogether and gold value has no upward limit.

    One just has to decide where on that scale we are at present.

  7. Hi David,

    You might be interested to know that the CME, ICE and JP are accepting gold as collateral. Normal procedure is to use cash or T-Bills for collateral, so gold is becoming more money-like!


  8. The 1970 chart is probably the most important. This currently shows that the S&P500 has given better returns than gold during the period, but it may not do for much longer.

    The S&P has been a zombie market since 2008, kept alive by a relentless tsunami of money from quantitative easing. It will crash at some point, and by 2015 your chart will show gold has leapfrogged the S&P500.

  9. DS,

    In fact it is very cheap to store substantial quantities of gold, relative to a household's total wealth. You can buy a few ounces, put it in a safety deposit box for $75/year or so.

    For institutions it is even cheaper per unit, given the amount of gold held.

  10. Greg,

    I have guns and live in the country (where my pickup at?) but don't have gold. Am I odd?

  11. Mark here (the guy who questioned you posting a Strat as collateral).

    I agree compeletly its not money. Certainly within the confines of contract law, if there was any litigation regarding a transaction it wouldn't be protected as a neutral, easily means of exchange that would be legally regcongized. Remember that guy who tried to circumvent tax laws by paying his employees in old $20 gold coins (worth inthe open market what he wanted to pay them based on gold content) to circumvent tax laws? He didn't win.

    Its questionable that its even a reasonable store of value if one looks at it strictly from the perspective of the how questionable the transparency of the commodities exchanges are, and whether the pricing is being nudged in the direction of monied interests who seek to control the price and physical float.

    I trust the market for gold less than I do for stocks, and I know they're shady and opaque. I think its a medium term curency hedge, if you enter into the market at the right times and don't try to hang onto it for dear life for years on end.

  12. Anonymous Mark:

    Do you have some evidence regarding the ability of "monied interests" to control prices? All the examples I can call to mind resulting in substantial losses for the group trying to corner the market - the Hunt brothers, or Amaranth more recently. But this is an area of interest for me, so if you have some examples, please share.

  13. My mother once remarked that when she was a child, her family had to leave home to escape a communist revolution, and they lived off a string of gold jewelry that her mother kept. It sounded as if she believed that their paper money and bank accounts couldn't be traded for necessities like rent and groceries, but that one gold ring per week was enough to support them. These pieces must have been redeemed at a huge discount because in that part of the world they don't do alloys, but at least the family could survive until her father eventually found work paying local currency, at which point their family switched back from selling gold to buying it. If this story is true, then perhaps under certain unusual conditions, gold is a good store of value and it can become money.

    When she passed away a few years ago my grandmother's estate held only a few small pieces of gold jewelry. Most of their assets where in real estate, so apparently their gold phase was fleeting.

  14. Here is some recent data of interest here:

    The letter: "Gold and the US Dollar" specifically.

  15. Jeff

    I have not noticed a propensity for those who love guns to love gold but I have noticed a propensity for those who love gold to love guns.

    I think the hardcore gold bugs are very suspicious paranoid types and guns make them feel secure. People who value guns for whatever reason are not necessarily attracted to gold.

    Just one mans observation.

  16. Greg,

    Yeah, there's definitely the doomsday types who hoard just about everything.

    Anyway, I was just teasing you.

  17. Data question:

    In the 1st graph (since 2000), it appears that the price of goal has grown faster since early 2009 than S&P 500 Total Return index.

    Yet, in the 2nd and subsequent graphs, it appears that in the last 2 years, the S&P 500 has grown faster than the price of gold.

    Over the last 2 years, the S&P 500 and the price of gold have risen about the same amount.

    2-yr chart

  18. One might make the "store of value" claim conditional with much more accuracy. As in, "Gold is an excellent store of value when..."

    "...a central bank repeatedly attempts to ease to reduce stubbornly-high unemployment."

    "...the consensus of economists is that inflation cannot accelerate under a large output gap, no matter what action the central bank takes."

    "...the central bank creates in the economy an addiction to negative real interest rates.'

    "...the monetary authority must finance large fiscal deficits to prevent term sovereign rates from rising, as this would push the fiscal deficit yet higher."

    "...the central bank commits to markets that it will not tighten to stem commodity price inflation, thus giving a greenlight to further speculation in commodities.

  19. westslope: In your chart, is that the total return index (does it include the return from dividends)?

  20. To add to the confusion, some may be interested in this paper:

  21. Here's the Dow Jones to Gold ratio going back to 1900:

    It's a popular indicator in the investment community.

    What's the better store of value? A lot of it depends on your timing. If you pick the right moment to do your switches, then either can serve as the better store of value... at least for a while.

  22. Bonds are a little more of an institutional thing. Most Americans save in a savings/checking account with a low APR, usually negative returns after fees.

    One claim from I believe Jude Wanniski's book The Way The World Works is that gold has held value not just since 1970, but since the Roman Empire. Because of the special power of such rhetoric, such sweeping claims probably can't be defeated (in the sense that the proponents would be convinced to change their minds) just by pointing out that value has not held on a decades-long scale. (If logical counter-arguments worked, I could just point out that any time the ratio of gold-price to CPI or car-price or bread-price altered, i.e. any time the spot price decreases significantly, gold does not hold value.)

    So, sorry to say: "That was great! Can you do more?" but ... can you show more? I think the argument would be stronger with some centuries-scale comparisons.

  23. I don't think stocks are meant to be a "store of value". They're a somewhat speculative investment with significant, long-lasting volatility even in a widely diversified basket.

    (The gold bugs' viewpoint, as I've heard it, is that gold is a ultimate touchstone of value, meaning that it neither appreciates nor depreciates, but rather holds still in the face of wild swings in the rest of the open macroeconomy. Did the price of a car change in dollars? Well it doesn't count unless the price of a car in gold bars changed. Under this account the 1990's were a deflationary period for the US. And arguing that the price of a car in hours worked is what matters, simply doesn't work because "gold = touchstone" is axiomatic.)

  24. Well, the dollar is being devalued and the federal reserve is printing money like there is no tomorrow. This will make the dollar worth less and less until it crashes. This is what happened in Weimar Republic pre nazi germany. They kept printing money until the currency collapses. That is why gold will hold value and should be a better investment then the dollar over the coming years while the dollar collapses after the Euro collapse.

  25. David Andolfatto, keep writing.. the best fact over the internet... especially the gold graph since 1970.

    1977 to 2007 was almost 30 years cycle. It could be the same after this.. the worse part 1981 to 2004 the is no dividend/bonus with this trade.. look like flat to me. I wonder if during this stage inflation can be beat... I prefer volatile..;)