DR 058: 6 Reasons Gold is a Terrible Investment

A reader named Aaron sent me an email recently asking about gold and silver. He wanted to know if they should be a part of a diversified portfolio. He writes:

Hi, Rob.

I enjoy reading your tips, and I’ve put a lot of them in place for our retirement savings. My question is: what is your view on adding gold and silver into a portfolio, and how much?

This question leads right into the topic for this podcast and article: Is gold a good investment?

I think that - for most people, most of the time - gold is not a good investment. Here are six reasons why:

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1. It doesn't produce anything

If you own an ounce of gold today, a year from now, ten years from now, and 100 years from now, you’ll still own an ounce of gold. In contrast, if you own stock in a company - companies produce things.

Exxon Mobil produces oil and refines gasoline for the market. Apple produces consumer electronics that are in high demand. Companies worth investing in produce things of value.

This means that your investment in a sound company can - and hopefully will - grow over time. And don't think this is just about stock market performance. If you've invested in a solid company, its assets are likely growing, and its earning potential and actual earnings are growing.

If the company is paying dividends, those dividends should be increasing as the company enjoys more growth. In fact, with sound investments, you’ll end up recouping far more in dividends than your actual investment over time.

Of course, this takes some time, but this is, generally, what a sound investment in a good company will do. In fact, when you value a company, whether it's public or private, you look at its assets, past performance, and market position. All of these things help determine the company's income-generating potential.

I talk more about investing like a business owner in this podcast episode:

The point is that you’re ultimately assessing companies based on what they can produce in terms of income. A sound investment in a good company produces something.

Gold, on the other hand, produces nothing. There's no way to value gold other than by looking at what someone else happens to be willing to pay for it.

2. There is an over-supply

Gold does have some uses, but not a whole lot of them. It’s used for decorative purposes, jewelry, and a few industrial applications. But gold’s uses pale in comparison to the supply of gold.

There's simply no way that gold's industrial and decorative uses can match the available supply of gold.

When you think of other commodities like crops, oil, and gas, you'll see that these commodities have significant uses that can meet - or even exceed - supply. So the demand for these commodities ultimately determines their price.

There is some supply and demand element in the price of gold, but it's not anywhere near what you'll see with other commodities. And it's definitely not like a company that actually produces something of value.

3. Long term returns are terrible

The long-term, real return for gold is abysmal. When gold’s value goes up, it gets a lot of press and attention. Everyone is talking about it. We saw that back in 2011 when gold prices rose. But it’s since fallen quite a lot.

Back in 1980, the price of gold went up to $850 an ounce. It got a lot of attention, fanfare, and news coverage.

But long term, gold doesn't really go up that much. A study mentioned in the New York Times looked at the return of gold from 1836 to 2011. Once you factor in inflation, the long-term return on gold is just 1.1%.

To put that in comparison, treasury bills returned about 1%. Inflation-adjusted returns for long-term bonds were 2.9% over that time period, and stocks returned 7.4%.

So in spite of the fanfare gold gets when prices skyrocket, the long-term returns - after inflation - are simply terrible.

4. It's too volatile

We’ve seen even in the past few years how gold prices can go up and down rapidly. Its inflation-adjusted returns are just over the returns on treasury bills, but its standard deviation is over 13, which is huge.

It basically has the volatility of stocks and the returns of treasury bills. It's like the worst of both worlds. So if you're going to assume the volatility that comes with gold, why not enjoy the returns that come with stocks?

5. It's a headache

There are some real headaches that come with investing in and owning gold. For one thing, there's storage. It costs money to store gold, and it's subject to theft and destruction. Sure, there are ways around that. For instance, you can invest in ETFs as a way to get exposure to gold without actually owning it. But if you actually buy gold, storage is definitely an issue you'll need to address.

Also, the bid-ask spreads on gold can be significant. When you go to a coin dealer to buy an ounce of gold, the difference between how much they pay for gold versus how much they sell it for is significant. I know this from my own adventures in buying coins. I view my coins as more of a hobby than an investment, but even in this case, the bid-ask spreads really add to the costs.

6. It's a bad inflation hedge

In spite of what you may have read, gold is actually not a good hedge against inflation. The folks who love gold say that when inflation goes up, so does the price of gold.

However, studies show that this isn't true. It can be a hedge against crisis. When financial systems are in crisis mode like they were in 2008 and 2009, gold prices do tend to go up. But over the long term, they're not a good hedge against regular inflation.

For example, remember that in 1980 gold prices rose to about $850 an ounce. By 2002, the price was only $293 an ounce. It had fallen to 1/3 of its previous value. But what about inflation during that same period? It was up, on average, 3.9% per year.

So while the price of goods basically doubled, the price of gold fell to a third of what it had been.

Commodities, not gold

That’s my basic view of gold as an investment. I think most people are better off investing in a commodities fund. For instance, I invest 5% of my portfolio in DBC, a commodities fund that owns only a little bit of gold, among other commodities.

You can also hear more about getting investing exposure to gold in this podcast, where I interviewed Tuhin Ghosh of Motif Investing. I asked Ghosh about the motifs that included exposure to gold, and his views are a bit different from mine.

But the bottom line is that I just don’t think gold, in and of itself, is a wise investment.

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