What is gold (really)?
You’ve probably seen or heard commercials hawking gold as if it is better or safer than money. It is not.
In the distant past, gold had special importance when it was a universal medium of exchange and later served as a tool to stabilize exchange rates and thus the world economy. During financial crises, such as the stagflation episode in the late 1970s and the banking collapse in 2008, many investors rush to gold in kneejerk fashion. Some are opportunistic early buyers who foresee the panic. Most are naïve victims who buy gold after it has spiked well above its innate value.
Gold is just a metal, a mere commodity. It is comparable to wheat, oil, zinc, and pork bellies. Its price, in the long run, is most impacted by the demand for jewelry. It is not, nor will it become a currency. It will never replace cash.
Why you should avoid gold as a safe haven
It generates poor long-term returns
Over the years, gold has provided a rate of return worse than stocks and bonds. It has spiked up during times of panic, only to fall right back down thereafter. The closest indicator of a long-term trend for gold is the size of the global middle class. The economic rise of China and India had much to do with gold’s performance in the early 2000s. Even including that spurt, though, equities and fixed income instruments have beaten it.
It is not an investment
Like other commodities, gold is not really an investment. It rises and falls in reaction to supply and demand. Unlike stocks, which can grow through profitable operations, and bonds, which provide income, gold has no intrinsic quality through which you should expect some form of secular or steady performance.
It is volatile with episodes of massive loss
In finance, a safe haven should protect value. In bad financial times, a safe haven should be stable and liquid. When times are good, a safe haven may not have much upside but it should still be safe. In the early 1980s, when fears of hyperinflation ebbed, gold lost over half its value. More recently, once the crisis following the 2008 financial meltdown calmed, gold plummeted about 40%. These losses are worse than most stock market crashes. Over the past 50 years, gold has been almost twice as volatile as stocks and four times more volatile than bonds. Sure, gold rose dramatically as often as it fell. But this is the behavior of a speculative instrument – not a safe haven.
What you should do instead
If you define safety as ‘absolute avoidance of loss,’ you should seek protection in federally insured CDs, government bonds and/or money market funds. If you define safety as real after-inflation value in the long run, invest in stocks and bonds. Both provide better returns than gold with far less volatility. With lower returns and greater uncertainty, gold is the exact opposite of what a safe haven and investment in general should be.
* Data sources:
Stock returns: S&P Dow Jones Indices LLC; Standard & Poor’s 500 Index.
Bond returns: Federal Reserve Release H-15; An index of equal parts (25% each) Moody’s Aaa corporate bonds, Moody’s Baa corporate bonds, 5-year Treasury bonds, and 10-year Treasury bonds, rebalanced annually.
Cash returns: 3-month Treasury bill rates Gold prices: COMEX – Commodity Exchange Inc., New York Mercantile exchange since 1994.