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U.S. GovernmentIn part one of this series about gold as an investment, I talked about some alleged drawbacks of the precious metal as noted by two Wall Street Journal reporters. In part two, I discussed the points made by Jonathan Burton in his August 15 Journal piece. Today, I’m going to talk about the allegations made by Eleanor Laise in her January 29 article. To assist us, please note this FANTASTIC gold chart that can be viewed on the Journal’s website.
On January 29, Eleanor Laise highlighted several drawbacks of the yellow metal when serving in an investment capacity:
1. At the price that gold commands today, investors may be paying too much for any diversification benefit.
To begin, it’s interesting that Ms. Laise saw a diversification benefit, whereas Mr. Burton didn’t. Gold has risen more than 42% since mid-August 2007 (as of 1/30/08). However, to keep pace with inflation going back to 1980, gold futures would need to be above $2,228. Priced in 1980 dollars, gold appears cheap. A bargain? Not necessarily. However, supporters of gold point out that the yellow metal may have a lot more room to rise.
2. Gold hasn’t always performed effectively as a hedge against inflation.
A quick glance at the “Hot Commodity” tab on the Journal chart shows how poorly the metal has performed in this capacity since 1980. In addition, back in a post I wrote on November 16, I referred to a study conducted by Goldman Sachs, which showed that since 1988, the correlation between bullion and U.S. inflation expectations is just 36% (meaning the price of gold rises and falls with inflation expectations 36% of the time). The relationship between gold and U.S. consumer price inflation is only 23%.
3. The metal has extremely volatile price movements.
As I pointed out in part two of the series, a long-term investor might not be too concerned about short-term price gyrations. Along with the short-term trader, they may actually welcome such a characteristic, as it would allow them to accumulate more of the metal on price dips.
4. Many gold investments come with significant tax consequences.
A drawback, for sure. Ms. Laise wrote:
While the streetTracks Gold and iShares Comex Gold ETFs are popular among small investors seeking easy exposure to gold, the Internal Revenue Service treats them like collectibles, taxing long-term gains at a maximum rate of 28%. That compares unfavorably with the maximum 15% rate on long-term capital gains on securities and qualified dividends.
5. Because it’s seen as a safe-haven, gold attracts “emotional, speculative” investors who “can amplify its price gyrations.”
I wonder if that’s still the case. Laise’s colleague, E.S. Browning, wrote in the Wall Street Journal on January 31 that:
Historically, the world’s most enthusiastic buyers of the metal have been catastrophe-fearing “gold bugs” in places like India, where banks aren’t always trusted and currencies can be unstable.
Today, a different class entirely is powering gold’s rise: mainstream investors and money managers who once shunned it.
6. The dollar’s long decline may be near an end, which could hurt gold.
The dollar’s long decline may or may not be near an end. I’ve seen arguments for both scenarios. Personally, I believe that that any halt in the dollar’s decline would be only temporary.
7. Some advisers are no longer recommending gold to their clients.
Then again, some advisers are. Browning wrote on January 31 that Bessemer Trust, a New York institution that oversees $52 billion for wealthy families, had no money invested in gold three years ago. Today, it has about $300 million, due partly to new purchases and partly to investment gains, and plans to buy 10% more over the next few weeks. According to Browning:
Its managers say they believe the firm’s gold stockpile is the greatest in its 100-year history, in either dollar or percentage terms. That period includes the Great Depression, two world wars and the 1970s oil crisis.
Not only is gold being acquired by advisers for their clients, but also by central banks, whose sales in the late 1990s and early 2000s damaged gold sentiment.
Browning wrote:
Until recent years, central banks around the world were selling their gold holdings, at prices far below today’s prices. Now some central banks are buying.
8. Gold doesn’t always perform in a crisis. A recent study by Trinity College in Dublin found that, while gold generally holds up well when stocks decline substantially, the effect is short-lived.
It depends on what you mean by the term “crisis.” When Ms. Laise refers to the December 2006 study by Dirk Baur and Brian Lucey (which I have a copy of), a crisis is equated to a significant stock decline.
However, gold’s run-up over the past few years might not be as much event-driven as it is due to a crisis of confidence in the U.S. financial system.
The Journal’s Browning wrote:
Gold’s renewed luster shows the extent to which unease has replaced optimism since 2000. The 1990s marked a period of hope about the information-technology revolution, declining inflation and easier global money flows — all in a peaceful, U.S.-dominated world.
Today, optimism is clouded by terrorism, war, declining U.S. prestige, a technology-stock bubble followed by a real-estate bubble and the emergence of China and India as economic juggernauts. Investors’ affection for gold perhaps reflects their shaken faith in the U.S. financial system and a strong dollar — historically bedrock beliefs — as the housing debacle spreads.
9. Gold doesn’t produce earnings or pay dividends, and its returns over the long haul often look less enticing.
Regarding the fact that gold doesn’t produce earnings or pay dividends, Michael Kosares said in his book The ABCs of Gold Investing that:
The fact that gold does not pay interest is its greatest strength. If gold were to pay interest, the return on your gold would be dependent on the performance of another individual or institution.
Marc Stern, chief investment officer of Bessemer Trust, told the Journal on January 31 that one advantage of gold is that it isn’t regulated by any central banker who might be tempted to print money and thus debase its value. He said:
Gold doesn’t have a policy, gold doesn’t have a central banker, gold doesn’t have a printing press. It is a form of insurance.
Regarding gold’s long-term returns, in part two I talked about the importance of where one enters/departs the market. This is due to differing interpretations as to what “long-term” refers to. I’ve found that “long-term” can mean periods ranging from 5 to 25 years or longer, depending on the source. Regardless, Kosares noted in his book that:
Markets cycle. The performance of the stock market has been fundamentally tied to the performance of the dollar over most of the last century, and even though some on Wall Street would like you to believe in never-ending growth and profits, that is simply not the case in reality.
And the U.S. currency has been falling against other major currencies. Brett Gallagher, who helps oversee about $63 billion in international investments as deputy chief investment officer at Julius Baer Investment Management (a New York subsidiary of Zurich’s Julius Baer Holdings), told the Journal on January 31 that because of the Fed’s easy-money policies, “global investors in general are saying, ‘We don’t feel the dollar is a good store of value,’” and they are diversifying into other assets. His fund holds gold-related stocks and other commodities-related shares which may benefit from a weakening dollar. “Our interest in tangible assets such as gold increased in the fourth quarter” of 2007, Gallagher added.
As we have seen, opinions vary as to gold’s importance as an investment. However, to a growing number of investors the metal is still seen as “precious,” and serves as an insurance policy against an increasingly-unstable financial system dominated by paper “assets.”
(Note: The author disclaims any personal liability, loss, or risk incurred as a consequence of the use and application, either directly or indirectly, of any information presented herein.)
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