Since the days of the ancients, gold has been prized, coveted and viewed throughout the world as an asset with real inherent value. It’s still highly esteemed today and investing in gold is considered variously a hedge against inflation, a tool for diversification and a currency in its own right.
But is gold a good investment?
Many goldbugs cite the troubling depreciative nature of fiat paper currencies that aren’t backed up by anything real. How valuable can a currency be, they say, if you can print it in unlimited supply?
Warren Buffett, the CEO of Berkshire Hathaway (tickere: BRK.A, BRK.B) and perhaps the greatest investor of all time, understands that fear. Gold investors, he says, are “right to be afraid of paper money. Their basic premise that paper money around the world is going to be worth less and less over time is absolutely correct. They have the correct basic premise. They should run from paper money.”
Taking a closer look at gold’s qualities as an investment, it’s easy to see why the Oracle of Omaha has stuck to stocks. Here are five characteristics that show why a gold investment falls short.
Long-term returns are poor.
Let’s start with the biggest one. Investors are familiar with the phrase “past performance is not necessarily indicative of future results,” which is a sober reminder that mutual funds and managed accounts frequently mean-revert (or move back toward their average).
However, that implicit warning holds less muster when looking at the performance of entire asset classes over time. This, says Robert R. Johnson, principal at the Fed Policy Investment Research Group, is where gold’s inferiority comes clear.
Johnson and his colleagues in the book “Invest with the Fed” wrote that gold underperforms equities in all interest rate environments, despite its celebrated popular status as a hedge against inflation.
“From 1972 through 2013, common stocks returned 14.68 percent in falling rate environments while gold futures returned 7.85 percent. In rising rate environments, stocks returned 8.47 percent while gold only returned 4.86 percent. When rates were flat, stocks provided a gain of 10.61 percent and gold returned 8.61 percent,” Johnson says.
The first full year the dollar wasn’t tied to a set price of gold was 1972, so it’s an important year for comparison’s sake.
How do you value gold?
Finance nerds will tell you that the value of any asset is the present value of all future cash flows. Old-school Wall Street firms live and die by this concept, and many a blue-chip stock is bought or sold when the “models” – rigged with well-researched growth and interest rate assumptions – flash “buy” or “sell.”
Similarly, there are all sorts of ratios – price-earnings, price-book value, price-enterprise value, etc. – that investors use to gauge whether a stock is a steal or a ripoff.
These metrics don’t exist for gold, says Tom Cassidy, chief investment officer at Peoples Security Bank & Trust Company.
“The value of a company can be estimated based on forecasts of future earnings and the growth of earnings. Gold does not have earnings and, in fact, if you want to hold physical gold there is potentially a cost to hold and insure it. Gold is worth what people are willing to pay for it on that day,” he says.
“The value of gold is determined by supply and demand, which is very hard to predict. Demand typically goes up based on fear and not fundamentals.”
You can’t exactly put a dollar figure on a fear index, can you?
Gold investments don’t throw off cash.
One of the best things about stocks is their ability to produce income for the shareholder. Over time, not only do you get to keep your equity in a growing company, but you get to receive the stock dividends paid out over the years, too.
Johnson puts the dilemma simply: “A major disadvantage to investing in gold is that there are no periodic cash flows made to the investor. Unlike most stocks and bonds, there are no regular cash dividends or coupon payments made to gold investors.”
Also, cash isn’t used exclusively for dividends. It can also be used to buy back stock or reinvest in the business, neither of which apply to a nonproducing asset like gold.
Gold has little actual utility.
OK, so the famed precious metal doesn’t throw off cash. But neither does it really provide much utility in the way of production value, some argue.
The famously soft metal loses out to other metals like silver in that regard, which is frequently used in products ranging from electronics to medical devices to solar panels.
Gold, on the other hand, doesn’t have many industrial end-uses.
Gold is inefficient.
The final reason investing in gold simply isn’t a wise idea is its extreme inefficiency. Since it is a physical asset that people have a tendency to hoard, there are storage costs, and often security costs as malcontents have a tendency to steal it.
And in an ironic twist, the very metal that’s supposed to safeguard investors from runaway inflation and a print-happy Federal Reserve is also constantly experiencing an increase in supply. More and more, after all, is mined every year, increasing the world’s usable gold supply.
And then there’s the whole tax thing.
Tom Cassidy gets into it:
“Gold’s return is solely based on the price going up. Thus when you sell gold you create a capital gain, that in most cases will be taxed at the more favorable capital gains tax rate,” he says. “However, if one invests in gold in a tax-deferred account, the gains one receives will be taxed based on their income tax bracket, which is typically higher than their capital gains rate. So if an investor does want to own gold it should be done using taxable assets.”
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