Gold is Not an Investment

Nov 20, 2006 by

When I was born, my parents made the mistake of buying a small amount of gold and putting it away in the vault for my future. Little did they realize that the gold would be worth less today than it was worth when they bought it twenty years ago. Much less.

Historical Price of Gold

The prices in this graph are nominal prices, not real prices. A dollar in 1985 bought far more than a dollar buys today. It was not until 2001 that gold regained the nominal price that it had in 1985. In the last five years, the price of gold has sky-rocketed, but that has nothing to do with the value of gold, and everything to do with the uncertainty of the world and the weakening of the dollar.

 Imagine that I had sold the gold in 2001 at the price at which I acquired it. I would have actually lost a lot of money. $100 in 1985 had the same purchasing power as $164.59 in 2001, and $181.51 in 2005. (Determined with a purchasing power  calculator.) So, if I were to have maintained my wealth in gold, it would have had to have risen from $300/oz. in 1985 to $300 * 1.8151 = $544.53/oz. in 2005. If gold rose by 181.51% over the years, I would have not made any money. Even at gold’s high of around $700 in 2005, my real return would have only been ($700 – $544.53) / $544.53 = .286 (i.e. 28.6%). Over a twenty-year span, a 28.6% return is very lame. If the $300 had been invested in an asset with a lousy return of 5% per year, it would have been worth $795.99 in 2005. Accounting for purchasing power parity, this would have been a twenty-year return of 46.2%. While this is not great either, it shows that even a modestly performing investment outperforms gold. The price of gold in 2005 is the highest it has been in twenty years, which shows that this is the best of circumstances.

 Companies create value, while gold does not. Unlike petroleum, gold is usually not consumed when it is used. The amount of gold in the market increases over time through mining. In the past, the value of the dollar was pegged to a quantity of gold. When that was the case, no money could be made from investing in gold, as the value of the dollar went up proportionately to the value of gold. Now, the dollar is not tied to gold, and people use gold to protect themselves against inflation, not to make a profit. When the dollar gets weaker, gold gets stronger, and vice-versa. While profit can be made from short-term fluctuations in the price of gold, there is no profit to be made from a buy-and-hold strategy involving gold.

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2 Comments

  1. Paul

    Agreed. in fact, as more and more countries moved away from the gold standard, more gold entered the market.
    They used to say that it was long inflation protection, noting more. 100 years ago, an once of gold could get you a decent tailored suit. About the same is true today except, maybe the suit isn’t so nice.
    I think most people are looking for investments that beat inflation. nuff said.

  2. Adi(mturker)

    Although a hedge against inflation has its uses. The purpose of insurance is not to make a profit, but to prevent losses. Gold does not make value, but it can help preserve it.

    I would add that while the dollar was tied to gold, the power of the US Government was limited as well. If we consider the vast increase in the scope and influence of the government, a gold-based currency would be much more prosperous than today.

    Without the power to print money, a government has to resort to taxes. Unlike inflation, taxes can be directly linked to political decisions, and have direct political consequences. While inflation takes years to unravel, by which time the political or bureaucratic agents could be long gone, taxes reveal themselves directly into a loss of income.

    Other powers, such as that to wage war is also strictly limited.

    So all in all, gold is valuable, even if not necessarily as an investment.

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