The Case For Gold is Actually A Case Against Gold

Gold Is Not The Safe Harbor Many Believe

Over the past decade, gold has continued to be sold as an ideal investment to own in troubled times. Those making the case are usually gold producers and brokers who make money off of individuals buying gold. Most professional financial advisers would argue against a heavy allocation to gold under any circumstance. Most would also be comfortable with a small gold allocation of a few percent of the portfolio.

Those making the case for gold, on the other hand, argue for a heavy investment into gold. With the most aggressive (and predatory) arguing to convert entire retirement funds into gold. The GOLD IRA is a common sales pitch, which goes against modern portfolio theory, proper asset allocation, and basic concepts of diversification.

The Case For Gold

The case for gold is often made using vague assertions of what “the wealthy” are doing, fear tactics, and dire predictions about the collapse of the U.S. dollar and/or the U.S. economy. At its most extreme, gold is sold based on fear of a global meltdown resulting in a post-apocalyptic world.

There are five basic arguments that make up the case for gold. (1) The wealthy are buying up large amounts of gold, and so should you. (2) Runaway inflation is coming and gold will protect you. (3) The collapse of the U.S. Dollar is coming and worldwide trade will rely again on gold. (4) A worldwide meltdown is coming and gold will be the only thing of value left in the post-apocalyptic hells-scape.

But what if the pro-gold crowd is right?

The People Making The Case For Gold Are Right

Let’s assume the people making the case for owning, investing in, and hoarding gold are correct in all of their assertions, from the most dramatic to the most likely. The worldwide economy will melt down. The U.S. Dollar is heading for a collapse. Runaway inflation is coming and will devalue the dollar. And finally the wealthy are in fact buying up gold.

The Case Against Gold

In each ‘prediction’ above, gold is not the best solution to the problem. History demonstrates gold doesn’t actually react to inflation, economic slumps, or worldwide meltdowns in the way the pro-gold crowd suggests.

Upon analysis, once you move beyond the hyperbole and fear mongering, gold loses its sparkle. The arguments used to suggest a heavy investment in gold are the exact arguments which show you shouldn’t buy gold.

A Worldwide Meltdown is Coming (And Only Gold Will Have Value)

This argument ranges from warnings of a global economic collapse to a zombie apocalypse. Regardless of whether the worldwide meltdown takes the form of economic collapse or a post-apocalyptic world, gold will not be the solution. To see this, we can look at the last massive worldwide economic meltdown: all the way back in 2008.

The 2008 Global Financial Crisis

2008 was about the best test of a global financial meltdown we could get. According to the sales pitch, gold value should have shot through the roof. But the gold sellers’ theory didn’t play out in the global financial crisis. Instead, gold prices rose in the months prior to the crisis, and peaked as the crisis began with a high of $1,109 in March, 2008.

As the crisis unfolded, gold prices dropped along with every other investment. Gold bottomed out at $825 in October, 2008, and ending the year down at $1,011 in December, 2008. Gold’s massive run up didn’t begin until August of 2009, when stocks, real estate, and the rest of the world economy were recovering too. Gold finally peaked at $1,969 in August of 2011 and has dropped since then to $1,250 as of last month.

During gold’s rise from August 2009 to August 2011, the S&P 500 increased by 30%. Counter to the theory, gold acts in a similar way as any other investment during economic crisis and recovery. If you had invested in either gold or the S&P 500 at their lowest point of the financial crisis, you would be pretty happy today. Except, while gold has increased 52% since its 2008 low, the S&P 500 has more than tripled in value.

End of Civilization Apocalypse

Some may be saying the 2008 crisis wasn’t a big enough crisis. The real thing gold protects against is a complete collapse of civilization. Unfortunately, history and logic don’t support this premise. Looking at the recent collapse of Venezuela, the people aren’t using gold as currency. Instead, they are apparently turning to bitcoin and “Rare Pepe” digital trading cards to buy food. Historically, cigarettes have been a favored currency of societies in collapse, just as they are in prisons.

Gold is actually a poor currency substitute in time of societal collapse. It is heavy, hard to break into smaller amounts, difficult to measure, difficult to hide, and it has no use other than as a medium of exchange.

But probably the best example can be seen in the television show The Walking Dead. Whether a zombie apocalypse or a collapsed society, people will be solely focused on survival. There has never been an episode of the show where the characters search frantically for gold bars or coins. If you want to invest for the end of the world as we know it, buy food and bullets.

The Collapse of The U.S. Dollar is Coming (And Gold Will Solve It)

The fear-mongering about the collapse of the U.S. Dollar seems to be presented with two possible outcomes. Either (1) a massive recession and coinciding drop in U.S. investments, or (2) world governments will revert the gold standard. History has shown in recessions gold doesn’t fare any better than stocks. Additionally, reversion to the gold standard is unlikely based on how world finances are currently structured, and would be a poor model to move toward.

Massive Drop in U.S. Investments

During the tech crisis of 2000, gold prices dropped in value just like everyone’s tech-heavy retirement accounts. The price went from a high of $451 in October 1999 and steadily marched downward to a low of $360 in April 2001. Gold began its recovery the same time as all other investments and the economy around 2002. We saw the same pattern of gold devaluing during 2008 in the analysis above.

100 Years of Gold Prices and Recessions

During recessions (the grey bars) gold prices (blue line) are more likely to drop in price than go up. Gold does tend to increase in value, but it is more likely to happen during good times than in bad. As a result, gold makes a poor hedge against a recession.

A Reversion to the Gold Standard

The world economy is more interconnected and interdependent than it has ever been in history. In ancient times, gold was needed as a foundation of currency to allow for countries to quickly understand the value of their currency verses another’s. Now, however, global communication, computing, and the Foreign Exchange (FOREX) makes that irrelevant.

The World Has A Standard, Just Not the Gold Standard

Worldwide commerce is managed by the United Nations, the World Bank, and the International Monetary Fund. The World Bank and the IMF were created during the 1944 U.N. Monetary and Financial Conference, affectionately known as Bretten Woods.

Gold salespeople argue the world still needs something as a standard for worldwide trade. But the world does have something: the U.S. Dollar. During the Bretten Woods Conference, the delegates agreed the U.S. Dollar would be the standard upon which worldwide trade would be based. As a result, the U.S. provides the stability the gold standard used to.

Some argue the dollar shouldn’t be the standard upon which international trade is built. After all, the dollar is simply paper with no real value except that people think it’s valuable. Well, gold is just a rock with no real value except that people think it’s valuable. Yes, gold is also shiny; but the U.S. Dollar also makes wicked paper airplanes.

Why Paper Beats Rock

In today’s economy, a paper currency which can be created from nothing is far more relevant as a standard than gold would be. Gold has a limit to how much can be mined and produced; there exists only a finite amount of gold. Paper currency (fiat currency) is created out of thin air with no natural limit.

In this way, the potential value of the world economy is far more similar to paper currency than gold. There is no limit to the amount of value a modern economy can produce. Technology has, throughout history, vastly expanded the production capacity of societies. Producing food used to require 98% of the population working full-time on the effort. Today, thanks to technology, a tiny fraction of the U.S. population works in food production.

As technology advances at an ever-more rapid pace, the production capacity of our economy expands too. Not only do we produce faster, but new products and jobs are created which were never dreamed of before. With no limit to the production capability of our economy, it makes more sense to have our money be able to expand in a limitless manner as well.

Runaway Inflation is Coming (And Gold Will Protect You)

The concern with fiat currency, of course, is the potential for inflation. Moderate inflation (around 3%) is actually a good thing. Rapid inflation, however, is a major concern for investors and one of the core risks which can erode wealth. Managing inflation risk should be a major component of your investment strategy. Unfortunately, gold is extremely poor at managing inflation risk.

Research Says Gold Doesn’t Hedge Inflation

A study published by the CFA Institute showed gold is an extremely poor hedge against inflation. In fact, the study demonstrated the rise of inflation has almost no correlation to the price of gold.

Between 1985 and 2012, inflation rose between 2.3% and 7.3% per year. Gold, on the other hand, delivered trailing annual returns of - 6% to almost 20%. Further, gold was not always going up when inflation was higher. In fact, the stock market is more closely correlated to inflation than gold is.

The Best Inflation Hedge

If you want to protect yourself against runaway inflation, don’t buy gold -- buy TIPS. Treasury Inflation Protected Securities offer U.S. Government-backed bonds with face values which increase with inflation. If you invest $1,000 into a TIPS, and 20% inflation hits, your bond will now have a face value of $1,200. Additionally, TIPS provide interest payments, whereas gold just sits there. Even more desirable, the interest you earn increases with inflation along with the face value.

"The Wealthy" Are Buying Up Large Amounts of Gold (And So Should You)

The vague statement that “the wealthy” are buying up large amounts of gold isn’t often supported. Even if this were true, the finances of the ultra-wealthy have little to do with your finances.

Strategies which work for the wealthy would actually harm your finances because the ultra-wealthy already have a money. Their entire strategic playbook is designed to maintain the status-quo; to avoid change. You, on the other hand, are trying to create change in your personal finances. You can’t use the same playbook as the ultra-wealthy because their core goal is literally the opposite of yours.

Additionally, it is important to put the numbers into perspective. Although hearing a billionaire has purchased $10 million of gold may sound like a lot of money to you, to them it is chump change. The Heinz family buying tens of millions of dollars in gold represents maybe 1% to 2% of their net worth. And that’s how much of your portfolio gold should make up. If you have a quarter million dollars invested in the stock market, by all means buy a couple thousand dollars’ worth of gold.

George Soros Has Invested $246 Million In Gold

The billionaire investor George Soros has made a $264 million investment in gold, this is true. But Soros didn’t buy gold. Soros purchased Barrick Gold, a producer of bold bullion. In other words, Soros bought the company that sells you the gold.

Soros doesn’t think he can make a profit investing in gold, he thinks he can make a profit selling gold to people convinced gold is a good investment. The people who got rich in the California gold rush weren’t the gold miners. They were the people selling picks and shovels to others after convincing them they could get rich digging around the dirt.

You also have to realize that George Soros is estimated to be worth $25.2 Billion. This $264 million investment represents 1% of his net worth.

China and Russia Are Buying Billions in Gold

Another statistic going around the ‘invest in gold’ web is that Russia and China are stockpiling gold, buying up billions of dollars’ worth. These unsubstantiated claims, even if true, should not be a motivation for you to purchase large amounts of gold.

Governments are fundamentally different than people. Governments print their own money, set interest rates, manage currency exchange values, and attempt to control inflation. Their uses of gold go far beyond “savings and investing.” As such government actions should never be used as a model for personal investing.

Even still, “billions of dollars” is an incredibly small percentage of the national wealth of Russia and China. China’s national wealth clocks in at $23.4 trillion while Russia adds another $1.1 trillion. Even if Russia and China purchased $50 billion in gold, it would account for merely 0.2% of their national wealth. That is less than one quarter of one percent.

Gold’s Place In A Portfolio

Ultimately, I am not against owning gold as an investment. I do believe gold has a place within a portfolio, either as a component of a commodities allocation or possibly as a part of the cash allocation. Before you purchase gold or any other investment, consult the advice of a professional financial adviser. The gold sales rep may tell you they’re financial advisers, but for every financial problem you present them, buying more of their gold always seems to be the answer.

Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at info@purposefulfinance.org