Field of play
Gold is a way of going long on fear
My topic today is whether gold can be thought of as a useful part of an investment plan. I will admit off the top that in almost fifty years of investing I have never invested either directly or indirectly in gold. I have never found it the least bit attractive. But, never say never.
Keep an open mind
John Templeton urges us to always remain flexible: His Maxim 19. “Never adopt permanently any type of asset, or any selection method. Try to stay flexible, open-minded, and skeptical. Long-term top results are achieved only by changing from popular to unpopular the types of securities you favor and your methods of selection.”
The person with a truly open mind is free from preconceived notions and always alert to changing his mind. It is the ability to recognize that one has made a mistake or taken an erroneous view or that the world has changed. It is the ability to revise one’s opinions in a heartbeat. In modern psychology speak this is referred to as avoiding Path Dependency. (Taleb, N. N. (2005). Fooled by Randomness, The Hidden Role of Chance in Life and in the Markets) p.239.
Protection in a time of crisis and inflation
Supporters of gold say that it will protect your capital in times of crisis. It is also said to be a store of value, protecting you against inflation. Everything I have to say about gold also applies to Bitcoin and its digital cousins.
Let’s start with inflation. If we look at the period from 1975 to 1985, inflation and a stagnant economy were the order of the day. It was the worst inflation in the last 100 years. The price of gold performed well. In early 1975 gold was $180 per ounce. In the late 1970s there was a true gold bubble and gold went to $760 per ounce. And then it popped. By 1985 it was $300 per ounce. During that entire period I was 100% in stocks and my arithmetic average return over the ten years was 19.6% not adjusted for inflation. The compounded return would have been about 17%. And adjusted for inflation, the real compounded total return would have been just over 10%. I would not have done any better in gold which would have returned less than 7% per annum over the period. In fact, over the period from 1975 to 1985 gold failed to keep pace with inflation. In other words, gold’s real return was negative.
As for crises, I have invested through a number of ‘crises’. I recall the OPEC oil price shock of 1973, the stock rout of 1974, the inflation crisis of the late 1970s and early 1980s when interest rates went over 20%, the stock rout of 1987, the popping of the Japanese bubble in the late 1990s, the recession and bear market of the early 1990s, the Asian crisis of 1997, Russia’s default on its debts of 1998, the popping of the Dot Com bubble in the early 2000s, the Great Financial crisis of 2008 and the current covid crisis that began in 2020. During all these crises I never felt the need to buy gold. And with the benefit of hindsight, I am satisfied gold would not done anything to help our family’s retirement savings. I have always invested in stocks with a long term horizon. You can compare stock investing over the long haul with gold over the long haul in the chart below.
We can look at a chart of stock returns compared to returns from gold over a period of two centuries. It is taken from (Siegel, J. J. (1998). Stocks for the Long Run – The Definitive Guide to Financial Market Returns and Long Term Investment Strategies.) The chart shows real (inflation adjusted) total returns.
This chart makes it clear that stocks outperform gold over the long haul.
What is investment?
Let’s go back to the basics.
Warren Buffett defined investing as an attempt to profit from the results of the enterprise. (Lowenstein, R. (1995,2008). Buffett, The Making of an American Capitalist) p.273
Buffett wrote: “Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.” letter to shareholders, 2011
Gold can’t be viewed as an investment in this sense. Companies do something remarkable that gold can’t do. Companies can create value.
In 2001 Buffett wrote an essay in which he said: “Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back in the business. Thus there is an element of compound interest operating in favor of a sound industrial investment.” This is how companies create value. See here for essay.
In the 2011 letter referenced already, Buffett wrote: “Gold … has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end”
What he is saying is that gold cannot create value. It is not ‘procreative’. It is simply a fungible commodity. If you own gold directly you also have to pay storage costs. On the other hand, companies can be procreative. They can create value.
When you think about it, gold’s price is capped by the cost of extracting more gold. The world is not running out of gold. If the price of gold goes up, more mines will come into production.
Bitcoin and its cousins are also fungible commodities. They are also non procreative. Non-fungible tokens are also non procreative. A collectible artwork is also non-fungible. But alas, it is also non-procreative. Non-fungibles also have to be stored and sometimes insured, which costs money. I suppose with art you can always look at it and get some pleasure. None of these are investments in the sense defined by Buffett.
The case for gold
The simple question with gold is whether it acts well to protect your capital in times of crisis or inflation. The store of value argument has some merit. The problem is in the timing. It seems that the more people are fearful of a crisis or inflation, the higher the price of gold goes. On the flip side, once they lose their fear the price of gold sinks. If gold is used as a temporary protection, one has to get the timing right. Otherwise, you end up buying high when all around you are afraid and selling low when the crisis has passed. If gold is thought of as a permanent part of one’s portfolio, say 10% or 20%, the problem is that over the long haul gold will do nothing for you.
I came at this post with some preconceived notions about gold. I have tried to re-examine my thinking in light of everything I have read and experienced. I still can’t find any place in our family’s portfolio for gold. Nor can I find any place for Bitcoin.
To did more deeply into how the stock market works, the concept of risk, the role of volatility and the relationship between the economy and the stock market, check out the Motherlode Part 1: The Field of Play
That part contains the following chapters:
1. Stocks Beat Every Other Asset Class
2. Is it Worth it?
3. Is it Possible?
4. Risk and Uncertainty
5. Efficient Market Hypothesis
6. Inefficient Market Hypothesis
8. The Economy and the Stock Market – Cycles and Trends
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