25 Comments

  1. Survival Acres Blog » The Myth Of Gold As Inflation Hedge December 3, 2007 @ 12:33 am

    [...] I received an email from Politics of Debt Admin, author of The Myth of Gold As Inflation Hedge. [...]

  2. Franklin December 3, 2007 @ 4:56 am

    To the friends in survival acres (in response to http://survivalacres.com/wordpress/?p=1050):
    I do not advise investing in the Dow as opposite to gold. As a matter of fact, I don’t provide investment advise at all. The article is just pointing out that for all its dazzle, gold is not a better hedge against any economic danger than many other investment vehicles (some of them perceived as riskier than gold).
    If your scenario is one of doom, buying food, land in a mild climate and more importantly learning how to produce your own food may be a better investment than any financial vehicle.
    In the doom scenario I don’t see why having gold would protect you any better than having the knowledge to survive in harsh conditions. Learning how to produce goods, anyway, is always the best investment, no matter what your view of the future is.

  3. Tyler December 4, 2007 @ 5:19 am

    I have thought gold to be a lousy “investment” myself. Gold appreciates NOT in tandem with rising inflation in an evenly flow, but in bouts and spurts with a dollar crisis, either during periods of temporary high inflation, or with a falling dollar as we have seen the last year and a half. Lately, I have changed my viewpoint somewhat. Gold makes a lousy investment over the long run, and it makes for a lousy hedge against inflation that has been rising steadily for the last thiry years. Gold does make a good hedge against the inherent forces of central banks, goverments and deficit spending that ruins fiat currencies over the long haul as history has attested.

    In a doom scenario, especially related to peak oil (PO), hyperinflation will be destroying all of our savings long before we run out of food, heating for our homes or to keep the electrical grid running. For doomers, Gold WILL be the hedge that protects wealth during the first stages of the plateau period of PO, and that will be the coming hyperinflation.

    If anyone can point me to a time or place in modern history (Roman emprire onward) where gold was not accepted with some sort of value during war, famine or ruin, then name the place and time.

    Don’t invest in gold, buy gold for the day when your fiat currency hyperinflates. This is from one who witnessed the hyperinflation in Argentina.

  4. Franklin December 4, 2007 @ 3:56 pm

    Hi Tyler,
    I do not deny that gold may be a good speculative instrument, and I do agree that in certain circumstances it may be a way to transport purchasing power geographically and over time. During hyperinflations, though, most everything will behave similarly: Short-term bonds, short-term loans, gold, art, jewelry, real estate, food, etc. Savings are affected, long-term fixed-rate loans are affected, and salaries above all are affected, etc.
    Since you bring about the case of Argentina, one of the most successful Argentinean entrepreneurs during the inflationary cycle was the owner of a wholesale supermarket. He would sale cash and buy paying at 30, 60, 90 and 120 days. By the time he finished paying a can of tomatoes, his cost would be ¼ or less than his sale price.
    A funny bit:
    This was before they instituted scan machines so he had an army of people going around the supermarket re-pricing the goods on the aisles. When they finished with an aisle, they will increase the price and start over again.

  5. Jonahtrainer December 9, 2007 @ 9:52 am

    Your post seems to be fairly loose with its language.

    First, Federal Reserve Notes are money substitutes not money. Synthetic commodities (money substitutes) are only good for what they will buy (commodities). So, gold is money because of intrinsic value. As such, gold and Federal Reserve Notes compete as currencies (mediums of exchange).

    When a transaction takes place (a pizza is traded for a $20 FRN) it is not complete. Why? Because the $20 FRN does not extinguish the trade. The $20 FRN has no intrinsic value and therefore must be exchanged before the transaction is completed. Someone sometime will be stuck with the FRN when it can no longer be exchanged for any real goods. They will be left holding the bag. Every money substitute monetary system has always collapsed and always will because by its nature it is unsound. By contrast, if the pizza is traded for gold/silver/oil etc. the transaction is completed when the goods trade hands (title) because both have intrinsic value. Thus the FRN is a money substitute and gold is money.

    The investment aspect is irrelevant to its definition but the price of gold is heavily manipulated to keep its price low. Why? Because a central bank’s power to issue money substitutes is incredibly more valuable than a portfolio asset. See gata.org for more information on central bank intervention in the gold market to suppress gold’s price relative to money substitutes. You say a US Treasury has ‘risk 0.’ This is puzzling. Gold is the risk-free investment. Treasuries have counter-party risk, the issuing government. History is littered with governments that have collapsed. However, the gold mined during their tenure still exists and has its intrinsic value. Gold has no counter-party risk and is therefore risk-less. Yes, sometimes Treasuries are a better investment than gold but investors should be compensated for the risk they take on.

    You probably also use an incorrect definition for inflation. Inflation is a purely monetary phenomenon; an increase in the money supply. Many people think inflation is the probable effect of rising prices. How do you get the data to calculate the money supply? If you use the CPI numbers we both know, as Greenspan stated, they ‘have no basis in reality.’

    The value of gold is not necessarily as a place to store capital but as a unit of account for measuring one’s capital and making investment decisions. It is the measuring stick because it is predictable and reliable. Actually, most people don’t keep much of their liquidity (cash balances) in dollars, gold, etc.

    Now money substitutes are a relic from a bygone age. They were a result of technology. Technology has now provided for a more efficient monetary system. Banks and central banks are now completely irrelevant and unnecessary. With sites like GoldMoney.com and Prosper.com why would anyone need a bank? We live in interesting times!

  6. Franklin December 11, 2007 @ 7:22 am

    Jonahtrainer,
    Gold is not a risk free investment. As a matter of fact, if you bought gold in the 80s peak you would have waited until 2005 to see a penny.
    If it trades as a commodity, acts as a commodity and it is used as a commodity…
    Inflation is a monetary phenomenon, if you read the next post you will see that although the monetary supply has been growing continuously gold did not act in any way as a hedge. It peaked with the commodities peak of the 80s and crashed later to be rising now again.
    I can not see any correlation between the price of gold and inflation or monetary supply expansion. If you can show me the correlation I will appreciate it.

  7. Anonymous December 15, 2007 @ 1:17 pm

    Franklin, you said:
    “I can not see any correlation between the price of gold and inflation or monetary supply expansion.”
    You are kidding, right? There are plenty of charts out on the web that show the inverse relationships between the money supply and the price of gold. Dig a little.

  8. Franklin December 15, 2007 @ 6:24 pm

    No kidding! I’ve seen plenty of charts. At some point I even subscribed to the idea that gold is a hedge against inflation.
    And I still think that gold is a great trading vehicle during inflation, but just that. After the inflation scare subsides, gold loses value but everything else does not (we have never seen a period of deflation that reverts the overall prices to the previous level).
    The only case of deflation, as a matter of fact, was during the great depression, and gave birth to Keynesian economics, which have been with us ever since in one way or another.
    So, I repeat, gold is a trading vehicle during times of inflation, but has to be sold at the peak of the inflationary cycle, otherwise you get stuck with a lose for 30 years. Gold is not a hedge against inflation, which in a Keynesian world it seems to be a way of life, but it is a hedge during inflationary runs, but then again, many other vehicles are.

  9. Matt April 14, 2008 @ 11:04 pm

    Gold is an investment against real inflation and is a great investment…
    Gold is money and has been money for over 5000 years which acts as a store of value when compared to purchasing power and not against inflation for the simple reason that the inflation figures are fudged and don’t give a true reflection of what is happening to prices. For example the inflation figure is usually measured minus fuel and groceries??? Real inflation can only be measured in terms of M3 or money and credit growth which is up over 40% in the last 2 years alone. I think this figure is more a reflection of what is happening at the petrol pump or in grocery stores,something we can all atest too. But ofcourse the focus is on the ‘core’ inflation numbers which is ridiculous in itself because nobody pays with core dollar bills, we all have to use regular dollar bills.Inflation is also an incorrect term – inflation is not rising prices, it’s the illussion of rising prices, it is infact loss of purchasing power of the monetary unit and is as described by the Oxford Dictionary “an increase in available currency, causing inflation”. Prices don’t go up but money goes down in value. take a 1 ounce gold coin in ancient rome – with that coin a man could buy a toga, a hand crafted belt, a hat and a pair of sandals. In 1920 the price of 1 ounce of gold was approx $20 U.S. With that $20 U.S one called receive those funds on exchange for their 1 ounce and walk into any mens clothing store and buy a fine suit, shirt, hat, belt and shoes. Today gold is worth $900 U.S and one can exchange their gold for this amount and purchase the same still – but what would your $20 U.S get you today as a store of value in itself? Not much. People are richer in number but confused as to why they feel poorer. What did the DOW buy you in your examples of yester year compared to what the DOW can buy you now? Not what it purchased you then. The real price of goods has not changed in value in thousands of years but rather the tool that we meaure them by has – fiat dollars. Why? beacuse the labour and effort to mine one ounce of gold is equal to all the labour and effort to produce all those other goods combined – fairness and equity of the time labour that has gone into the exchange. Alan Greenspan himself said in his book ‘gold and economic freedom; in 1967 that “without gold their is no way to protect savings by confiscation through inflation.” Do you disagree with the former fed chairman? Anytime governments get involved in free market processes the ultimate result is destruction of currency through the debasing of money by the process of creating capital out of thin air, or – inflation. The other factor that you have not accounted for is the interference of the gold market by government to supress price – which they have admitted to because gold is in direct competition to fiat currencies. Why does your central bank hold tons of gold but happy to issue you with paper notes? Alan Greenspan again stated “central banks stand ready to lease gold in increasing amounts should the price of gold rise” or, if gold rises in price we are going to hammer it down to keep the appearance of value in our currency. Why did government in past days forbid the ownership of gold? Come on, you tell me? Do the due diligence and the right thing by yourself to understand what gold really is – true free market money that cannot be manupilated over the long term. The Islamic gold coin the dirham states on the coin ‘zero inflation in over 1400 years’. A chicken 1400 years ago cost 1 gold dirham – today it still costs 1 gold dirham – not bad. By the way how long have fiat currencies historically lasted? – rarely more than one hundered years across all currencies and all nations. Fiat currencies always end, it’s designed in their nature to do so. By the way since 1913 the U.S dollar has lost over 96% of it’s purchasing power – gold gets you exactly the same now as it did then. So tell me what has been the better investment. I’m not an American but even i’m aware of the saying ‘not worth a continental’ maybe those smart forefathers of the U.S understood something we didn’t and is the reason they wrote in the U.S constitution that the use of fiat or paper money was prohibited and that only gold and silver were to be used as money. Was it their experience, wisdom of years or ignorance of a modern economic environment that caused them to say such things – such things which are still written in your Consitution today. I can go on and on with example after example but this is not the forum for an essay. Is gold both a great investment and a hedge against inflation – over 5000 years of history should be able to answer that for us all.

    Cheers, Matt

  10. Franklin April 15, 2008 @ 1:07 am

    @Matt,
    If I were to live 5000 years I would agree with you. Since the boom and burst cycles of gold seem to run around 30 years or so, I would say it is not a great hedge for the average human.
    I wrote another article on gold regarding the current value as money. Since gold is not a reflection of the economic power of a country, another commodity should take its place, something that reflects the technological and military power of the country hoarding more of it. I would think that something related to energy, like uranium would be a better form of money now than gold.

  11. The Politics of Debt » The Gold Scam April 20, 2008 @ 1:16 pm

    [...] cost 1 gold dirham – today it still costs 1 gold dirham” (you can see the complete comment here). This argument has a number of problems, the first, and more obvious one, is that 1 dirham weighs [...]

  12. Matt April 21, 2008 @ 7:57 pm

    5000 years not neccessary. What about the last 3 or 4 generations since 1920??? Again, what would gold buy you now compared to the dow or the greenback in general. Don’t focus on numbers, that’s what we’ve all been trained to do but rather focus on purchasing power. Incedentlty I challenge you to take a look at a chart of the last 80 years of gold and then tranpose that against the last 80 years of greenback purchasing power. The inverse relationship if not 100% accurate is at worst uncanny and at best the best refelection of what has gone on with gold and it’s purchasing power. Why has China gone on record and stated that they are increasing there gold reserves from 1% to 10% in the next few years? Same for Russia, Iran and most of the Middle East. It appears the only people not buying gold are the West. Be prepared for the greatest wealth transfer in history in the next decade. You obviously don’t know your history gold has always been a reflection of power. Why does every central bank of the world hold it and then issue you with their paper? Every economic and political power always haeld gold in high esteem and in large anmounts. There has not been an empire that succeeded without it.Great Depression was brought about by France not inflating their currency inline with the rest of the world as pointed out by Bernanke himself in stating his reasons for the deflationary depression that occurred from 1929. Instead they hoarded gold which ultimately caused a contraction in the money supply. Every central bank wants it, every emerging political and economic heavyweight has got it and acquirying more of it, so why don’t you want it? You have to ask yourself what they know that you don’t, or you do know but ignoring. Generationl wealth both individually and empirically has always been transferred through gold and silver.Why? because all paper money eventually fails along with the paper wealth it represents.Rothchild who was not bad at transfering his wealth you’d say, said “allow me to issue a nations supply of money and credit and I care not who writes it’s laws”. A man who certainly understood gold and inflation. All the information is there as proof of how money works? Now you have either made a decision then gathered all the eveidence to support your A priority conviction as to what you think goes on or you are just unaware of history, fiat money and how gold really works.

  13. Franklin April 22, 2008 @ 9:00 am

    Matt,
    Since 1920 you could have made more of a fortune buying swamp lands in Florida than buying gold (and I mention this because in the 20s it was both an scam and a mania buying swamp lands that now are prime real estate). That the result of the event was positive to the speculator does not justify in itself the investment. It was a scam and a mania, and it worked out over the very long term.
    Looking at 80 years of gold and 80 years of greenback purchasing power tells me that gold is a commodity that oscillates in price with other commodities. If you look at the chart of platinum you will see a similar pattern, and platinum was never (that I know of) used as money by any country.
    Several months ago, I wrote an article showing the real price of the Dow (at the peak of the Dow) in gold, that’s it, if gold were still the standard for the US money. I think it helped my readers understand that the economy was not as good as it was portrayed. A few months later we started to see the tip of the iceberg of the real economy.
    Now, that is an hypothetical view. “This is how the economy would look if we still were in the gold standard”. The reality is that we are not. Gold is a commodity and needs to be traded as such.
    I don’t discourage gold speculation as I don’t discourage real estate or land speculation. However, I think that it is speculation and needs to be treated with the same care you would treat any other speculative position. Whether we like it or not, we live in a world of fiat money and this is only going to deepen as money becomes increasingly electronic.
    Those countries that have a gold standard and always had a gold standard will continue enjoying both the benefits and limitations of the gold standard. Those countries without a gold standard will enjoy the facility for generating credit and will suffer the implosion of the credit bubbles.
    I think that the best investment during inflation is still debt, but that’s another story.

  14. Jack May 25, 2008 @ 5:00 pm

    Matt, you’re wasting your breath. Franklin has a point of view, i.e., that “gold is a commodity just like any other” and your pointing out to him that governments and central banks hoard gold reserves, that the purchasing power of gold remains unchanged by the vagaries of the value of current fiat currencies during any time period are simply being ignored. Franklin is a student of investment, and therefore may have a hard time seeing that gold is not an investment, per se. It’s greatest use is perhaps as a way of protecting wealth. During times when the value of gold is low (relative to contemporaneous fiat currencies), stocks and other investments typically are returning high yields. The purpose of keeping a percentage of one’s wealth in gold is for times when such investments are low in value or even worthless. It is at those times that the prudent man will be glad he has his hoard of gold, to buy food and fuel, to sustain himself and his loved ones through difficult financial times.

  15. Steven September 4, 2009 @ 5:25 pm

    Just a clarification on a few points.
    First of all there are silver dirhams and they weigh 3 to 4 grams more or less just like the old roman denarius.
    The dinar is a gold coin that was about the same size more or less.

    Secondly even though gold and silver are money they are also wealth assets and some say insurance against fiat money disasters like the one we are all about to face.

    Thirdly physical gold and silver in hand has no counter party risk where as with other forms of wealth there is a great deal of counter party risk. Gold and silver is anonymus payment in full. Value for value and therefore
    is honest money as opposed to swapping debts and that leaves someone with debt notes that might not be tradeable at some point in the future.

    I say its better to have the ounces than to not have them.

    Steven

  16. The Myth Of Gold as Inflation Hedge: Is another bubble being created? « Wars & Rumor February 22, 2010 @ 5:52 pm

    [...] Gold Correction Seems Over via thepoliticsofdebt.com [...]

  17. Raju March 30, 2010 @ 1:53 am

    Pretty nice post. The graphs you provided are really great. You make the post clear to readers.

  18. JBond May 16, 2010 @ 6:24 am

    It seems any banker or financial adviser will try to discourage gold as an investment vehicle. With Greece already defaulting on its debt obligations as well as, Portugal, Spain, and Italy next in line, I would be careful about trusting my future to the stock market, or any investment relating to fiat currencies. History may repeat itself, but the worldwide sovereign debt crisis is a major threat to the worlds banking system, and fiat currencies worldwide. Not to mention, Japan, UK, and especially, the US have virtually no chance of getting out of debt anytime soon; therefore, leaving only two ways to pay back these deficits. The two ways are expanding the money supply, and raising taxes greatly. As I read in one of the comments above, gold is best as insurance in the event of a hyperinflation, or currency collapse. I still hold a diverse portfolio of stocks, short and long term bonds, and real estate; however, the gold is like having insurance in the event of a currency collapse, and it can happen.

  19. Anonymous June 5, 2010 @ 12:28 am

    Can I “lol” at this

    Seriously! Look at the bank’s positions on precious metal! They are shorting the hell out of it with high leverage… and trust me… this is not because they think it’s gonna go down but more for “price control”. A very high value of the gold and silver does not deliver good news for a fiat system let me tell you that…

    Consider also the silver market… Market is so small so it’s easier for the big one (such as JP Morgan Chase for a REAL example) to control the market. There is a LOT of short contracts at the moment… Those guys are freaking selling silver certificate when they can’t even cover their positions with physical silver.

    Anyway, I’ll let you imagine the next step in the silver chart in the coming months…

    As for what I saw in those comments and specially from Franklin in 2007… I just “lol” so bad… Let me just say this Franky… Go back to school

  20. Franklin June 5, 2010 @ 11:16 pm

    You can lol all you want. But then there is the market.

  21. Anonymous June 6, 2010 @ 8:58 am

    Bankers try to discourage gold because buying gold involves pulling ones money out of banks, and financial markets; therefore, no interest or fees can be earned on your fiat money.

    As for these Keynesian’s, I don’t understand how they can trust the banking system that has deceived them. If the economy implodes, if the infrastructure crashes I want something I can trade hand to hand. My father had a drawer full of 100,000 German Mark notes. They’re only empty promises now. People escaped Europe during the wars with money and diamonds sewn into the hems of their garments. You shouldn’t forget these lessons, and you shouldn’t depend upon banking “systems” and their rules and laws to protect you. They’ve already proven to be untrustworthy. Since the Bizantine Empire, every fiat currency throughout history has ended in hyperinflation. I guess many of the Keynesian’s think this is impossible to happen because our system is too “sophisticated” for this. In 1775, the US Continental currency ended in hyperinflation. If you factor the US’s enormous and ever growing debt obligations, it will be damn near impossible for our government to get out of this deficit without significantly devaluing its currency. Yeah, most of the currency flooding the economy is M1; therefore, no need to worry about inflation because it’s not M0 right? Wrong! The money will eventually be liquidated, and then circulated in to the economy. Wait till this happens!

    Some of the academics I went to school with think people like Paul Krugman and Joseph Stieglitz couldn’t possibly be wrong.

    After watching a great video with Hugh Hendry posted on Zero Hedge earlier today, I decided to search the archives of past-dated interviews with Mr. Hendry. Why? Because the establishment has such a one-sided agenda of hiding the truth from the public that their modus operandi is always the same when confronted with the truth in present day. The establishment which includes Finance Ministers, Treasury Secretaries, and yes, Nobel Prize winning economists, always attempts to ridicule anyone that exposes their fraudulent analysis and expresses dissension to their establishment views. In retrospect, when we listen to their past arguments, we can always expose their views as propaganda and their ridicule of opposition views as an attempt to maintain their veneer of lies and deceit.

    For example, consider some of Ben Bernanke’s famous predictions.

    June 20th, 2007 – “[The Subprime Crisis] will not affect the economy overall.’‘ – US Federal Reserve Chairman Ben Bernanke

    June 9th, 2008 – “Despite a recent spike in the nation’s unemployment rate, the danger that the economy has fallen into a “substantial downturn” appears to have waned.” – US Federal Reserve Chairman Ben Bernanke

    Consider establishment Princeton University professor and Nobel Prize winning economist Paul Krugman’s claims from September 2, 2009:

    “There was nothing in the prevailing [economic] models suggesting the possibility of the kind of collapse that happened last year.”

    Now consider this exchange between Eclectica Asset Management CEO Hugh Hendry and Columbia University professor and Nobel Prize winning economist Joseph Stiglitz below that occurred on February 9, 2010.

    Mr. Stiglitz unbelievably denies the fact that citizens are bailing out governments and banks even though governments and banks are tapping and draining the wealth of citizens through their bailout and austerity plans and clever new tax schemes. Stiglitz claims that “a bailout is what happened, uh, for Citibank, with the financial institutions, where, uh, they couldn’t, uh, they owed more than their assets.” He goes on to make the argument that the US can never accrue a debt burden to great to pay and will never have to be bailed out because they have a printing press and can perpetually devalue the dollar and print as many dollars as need be to pay the interest on their debt (Translation: American citizens will be willingly placed into infinite debt by bankers and the government)– an argument that either (1) reveals Stiglitz’s failure to see the nature of the monetary system or (2) exposes him as a puppet of the bankers. If the US government was a real person named Uncle Sam, everyone would call Uncle Sam bankrupt and Uncle Sam would be unable to obtain a loan from any bank in the world. If the Greek government was a real person named Alexander Markopolous, everyone would call that person bankrupt. But to Stiglitz, governments never have to be bailed out, because in theory, governments can print as much money as they want out of thin air, despite the treacherous implications upon their citizens of doing so. He says, “there’s no problem with Greece or Spain meeting their interest payments.”

    Hendry states that Stiglitz is utterly wrong in his assessments and interrupts Stiglitz by hilariously responding, “Hello. Can I tell you about the real world?” Banking shills like Joseph Stiglitz always argue that the problems of the global economic and monetary system are not with a fundamentally flawed system, but that the problems are merely just one of confidence. Sound familiar? (remember former US Treasury Secretary Hank Paulson’s similarly structured arguments.) Stiglitz argues that everything that is wrong with the monetary system will go away if only people would get on board the propaganda machine and just believe that the system is okay.

    With the benefit of nearly five additional months since that debate, the debate between Stiglitz and Hendry reveals Stiglitz as a propaganda tool of governments and bankers and Hendry as the champion of reality. Why pay hundreds of thousands of dollars to attend re-education classes?

    If you were to study the history of academia, you would realize that elite bankers, and in particular, the Rockefellers, provided the funding for much of the institutional educational boards, from the General Educational Board in America as well as the International Education Board. As such, they ensured that employees of the international global banking cartel occupied the boards of nearly every major institution of learning in the world from the early 1900’s onward, and directly influenced, as well as decided, what economic and monetary concepts would be taught to young adults worldwide…For this reason, obtaining an education in business or economics from Harvard or Princeton, outside of the connections you make, will hinder your ability to build wealth far more than it can possibly ever contribute to it.

  22. Anonymous June 8, 2010 @ 4:10 pm

    “franklin”…

    at my golf course in 1968, for $60 or 1.5 ounces of gold at the time you could buy a season’s membership.

    in 2010 that $60 would ALMOST buy you ONE ROUND of golf. That 1.5 oz. of gold would still buy you a membership.

    Point being, with real money, ie. gold, prices don’t inflate across the board. In fact, better productivity lowers prices.

    Printing press money like the us$ destroys the purchasing power of the dollar. That cannot be done with gold. Unless the alchemists have made a recent breakthrough;)

    I suggest you stop thinking about gold in terms of us$ and start thinking about the WEIGHT of the gold and its purchasing power in terms of goods and services.

    Gold & other precious metals are an unparalleled inflation hedge. In a world of fiat money and gov’t printing presses paper money is a counterfeiting scheme. And its about to come tumbling down.

    Gold = sound money = timeless medium of exchange
    -jay b

  23. If the bankers seize all gold via the FED and debt monitization, would people care anymore about gold? | Economic theory August 23, 2010 @ 6:16 pm

    [...] 2. It turns out that, historically speaking, gold doesn't keep its value very well. It may be good in times of crisis, but as a hedge against inflation, it loses. http://thepoliticsofdebt.com/?p=224 [...]

  24. Abel September 15, 2011 @ 1:27 pm

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  25. Anonymous May 21, 2012 @ 8:54 am

    I think gold would be worth very little in a doom scenario. Real estate, belonging to a community for mutual aid, weapons, ammo, tools, shovels, saws, seeds, salt, cooking oil, flour, fuel, candles, rope, good clothing, etc. would all be worth more than a pretty metal that’s good for jewlery and electronic contacts.

The Myth Of Gold as Inflation Hedge

Economics, Finance, Thoughts Comments (25)

If you have read my previous articles on gold, you already know my opinion (it is just another commodity with an interesting history). The myth of gold as an inflation hedge comes from a rather primitive observation, when the value of money decreases, the value of gold rises. The myth goes like this: if you bought 100 ounces of gold at the yearly average for 1969, you spent $4109, if you sold it today, you would have $79,400. That’s a gain of 1832%, or 48%, a year.

On the other hand, if you spent the same amount on the Dow Jones you had bought 4.7 shares of the Dow at the yearly average for 1969. Those 4.7 share would now be worth $73.825 (reinvesting dividends). A gain of just 1700%, or 45% , a year.

Gold sounds like a an excellent investment, right?

Wrong. And here is why.

First, the $79,400 you have now, are enough to buy… 100 ounces of gold. Basically you sold dollars to buy some gold and then sold the gold to buy some dollars. There is no loss, but neither any gain. The problem however, is that to make any money you would need to trade the gold. Holding anything without the intention to sell is not a strategy of any sorts. At some point you will need to somehow realize your investment. Otherwise is just a paper gain and just illusory.

And here comes the problem, because if you had sold your gold in 2005, you would have made $44,474, while you would have made $49,486.9 on your Dow Jones investment, without reinvesting dividends.

This chart shows, as positive values, when the Dow Jones was a better investment than gold, and, as negative values, the opposite.

As you can see, in some circumstances, the Dow proved to be a better investment than gold, and, at some other times, the opposite was true. The bottom line is, gold is not a particularly better hedge than other forms of investment if you don’t consider the timing of the transactions.image

Do I think gold is a bad investment in general? No! I think it is a great instrument for speculation, but, when you compare its yield year by year, you will notice that you can make or lose money, it is not a safe bet by any account. As you can see in the following chart, gold would have made you money only if you bought in 1971 and sold in 1974, or bought in 1976 and sold in 1980, etc. But the longest run you may have had would have been of 4 years, and that’s if you timed the market perfectly.

image

Now that we have proven that gold is not a superior investment if we don’t time the market, let’s see how it fares against inflation. To do this I will invite you to a thought experiment. Let’s imagine a type of good that in 1969 had the cost of 100 ounces of gold. Our good has some other characteristics as well, its price does not change based on supply and demand. This commodity is the most boring commodity on earth to trade, and consequently its name is Borodium. Borodium only changes in price based on inflation data and is the ultimate hedge against inflation. Borodium places an interesting problem though, how do we measure inflation? You see, if you calculate inflation with the Consumer Price Index, you will have different numbers than if you use 10 year notes, or 1 year notes. But that’s another story. No matter how you measure inflation, gold proves not to be a hedge against inflation.

The Borodium adjusted with the Consumer Price Index will be called Official Borodium, and this is its chart.

image

Now you can see why they call it Borodium, its price rises permanently and only adjusts for inflation. The value of 100 ounces of Borodium in 1969, as we said, was $4,109 or 100 ounces of gold.

For gold to be a hedge against inflation, the chart should be an ever rising slope, like Borodium’s. And yet, it is not, as you can see in the following charts.

image

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The claim of gold as a hedge against inflation is based on the fact that the value of 100 ounces of Borodium today is $23,461.49, and with our gold investment at $68,755.00, we made a nice profit, and we now have 250 ounces of gold.

However, if we had bought our gold in 1974, at any time between 1979 and 1984, or at any time between 1986 and 1989, our gold investment would have lost money against inflation, the opposite of a hedge against inflation.

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Again, how much of a hedge against inflation, and and how valuable as investment it is depends on timing the markets. For instance, had you bought gold in the peak of 1980 at 7 Borodium, you would have lost 80% of your money from High to Bottom, and as of today you would have lost 58% of your money.

That should be enough to dispel once and for all the myth of gold as a hedge against inflation. But I will keep on going because I am on a roll.

Now, we will see other ways in which Borodium is priced in the market. For instance, Borodium adjusts its price based on another inflation indicator by proxy, like the US Treasuries. We will use the 1 year and 10 year treasuries data because it is readily available.

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As you can see, gold, when compared to the yield of 1 year Treasury notes (risk 0), is not a consistent investment and behaves as many other speculative instruments.

Compared to 10-year treasury notes, it is even a worse investment.

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How bad? Let’s say that for gold to act as a hedge you would have had to buy in 1960 to see a return of 16% after 38 years, or at the bottom of 2001 to see a return of 110% today. Which is about the same you would have made buying the low of the Dow Jones in 2001 and selling the top this year.

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Franklin @ December 2, 2007

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