Why Gold Is a Bad Investment

April 9, 2018

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THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO.

The other day, a Twitter troll was trying to convince me that I was making a mistake by investing in the stock market. He claimed that he was a superior investor because he invested in gold.

This guy then cherry-picked some stats. He touted the return of gold since January 2000, stating that gold has risen from $280/ounce to over $1,300/ounce. That is a return of 472%. In contrast, the S&P 500 has risen from 1,498 to 2,604 in the same time period, a return of only 173% during the same time period.

On face value, he puts together a pretty sound argument. However, we all know that you need to do a little bit more research than that when it comes to investing.

Unlike gold, the S&P 500 provides dividends. Thus, a return of 173% is not quite the total return of the S&P 500 over the 18 years. When you reinvest the dividends, you will see that this increases your total return to 246% over the same period.

But even still… gold has done substantially better over the past 18 years, right?

The History of Gold

Well, first let’s discuss why people usually flock to gold.

Since the dawn of time, gold has held audiences captive. The first known evidence of human interaction with gold occurred in Egypt around 3,000 B.C. At that time, Pharaohs and temple priests greatly valued gold. In fact, the capstones on the Pyramids of Giza were made from solid gold.

Quick fun fact: the capstone on the Washington Monument is made up of aluminum.

Wonder why?

Aluminum was one of the most expensive metals back in 1885 during the construction of the Washington Monument. However, just two years later, the Hall-Heroult process made aluminum easier to produce, which caused the price of aluminum to plummet.

Okay, back to gold. The Egyptians were the first to create a currency exchange ration, which mandated that 1 piece of gold was the equivalent to 2.5 parts silver.

However, the Egyptians didn’t really use gold as currency.

Egyptian actually used agricultural products, like barley, within their bartering system. The Lydian merchants, of modern Western Turkey today, were the first to use gold as currency around 700 B.C. They produced coins called electrum, which were a mix between 44-55% gold and the remaining silver.

As you can see, gold has been around for a long time.

Gold as a Crisis Hedge

Fast forwarding a little bit, since the 1970s, when the U.S. came off the gold standard, gold has been used as a crisis-hedge when the next upcoming crisis was upon us. I’m sure you have seen one of the countless commercials that tell us that the stock market is going to plummet and that we should hedge with gold.

The Valuation of Gold

The problem with gold is there is no logical way for us to value gold today. Gold cannot be an investment as it never produces anything. The growth is completely dependent on someone’s belief that someone else will pay more for it in the future. Hopefully, you are seeing some of the similarities that gold has with Bitcoin and even the Beanie Baby craze of the 1990s. My wife recently found her old Princess Diana beanie baby. Too bad that thing is virtually worthless today. All that to say– gold, like Bitcoin and beanie babies, is not a productive asset.

Gold is not like a stock or even a bond. It does not pay a dividend or interest. Gold does not contribute to economic growth in the future. Hiding gold in a safety deposit box isn’t useful in growing businesses. The value of gold has always been driven by the fear that other asset classes will lose value and that therefore, gold will hold its value.

The problem with that is that gold’s value is completely determined on what someone else will pay for it when you are trying to sell it.

I do not believe that the stock market operates the same way. Companies that you buy into actually have ways to value themselves. There are balance sheets, income, and cash flow statements to evaluate a company’s worth.

How should you value gold today?

Some people think that it should be valued how it has always been valued. Back in the Roman ages, a Roman toga, belt and sandals cost one ounce of gold. So today, theoretically, the value of gold should be related to the cost of a quality men’s suit, belt and shoes. While there is some rational thinking behind this, admittedly, using a standard from 2,000 years ago seems a bit silly. However, if you think about it, a total of $1,300 isn’t far-fetched if you include a high-end suit, belt, and shoes.

But, gold costs you money to store. Let’s say that you’ve accumulated some gold along the way. Do you really want to store gold at home? Not exactly safe.

I know that in certain cultures, it isn’t uncommon to receive gold as a gift. However, the reason why I know this isn’t a good one. There was a rash of break-ins in my neighborhood a couple years back. What did they all have in common? Each home had a fair amount of gold in their homes. Many of these families lost thousands of dollars in gold as a result. I guess you have two options with gold- either store it in your home or in a lock box at the bank, which costs additional money to hold an “asset”.

What About Inflation?

I wish there was a direct correlation between inflation and gold rising at the same rate, but there isn’t. If you’re worried about inflation, you should be looking at Treasury Inflation-Protected Securities (TIPS) without the wild swings of the market.

Here is a chart of gold over the years. As you can see, gold has returned the same amount as the TIPS over the long term, without the volatility of the market. Most prefer that the market has a consistent arc that increases over time. The peaks and valleys of the gold market are not for the faint of heart.

Gold Price History in 1960–2014

Okay, back to my dear Twitter troll. His argument was that gold is a great investment over time. However, if you look beyond the 18-year horizon and instead look at the value from the start of the S&P 500 in January of 1928, it took 0.85 ounces of gold to buy a share in the S&P 500. Today, it now takes 1.95 ounces of gold to buy a share in the S&P 500. This means that gold has lost value, relative to the price of the S&P 500. So, why wouldn’t you invest in the S&P 500, since it has held up over time through numerous wars, recessions and Presidents?

Does this mean that you should never invest in gold?

If you have access to the internet and have the wherewithal to learn about the stock market and its returns, I would say there is no reason to buy gold.

However, if you live somewhere in the world without access to banks and have zero trust in the financial system that you live in, then maybe that makes sense. But really think before you do that. There should be at least one stock exchange that you trust to invest your money in.

Hopefully I have laid out an argument as to why gold is not a wise investment, but really just a hedge from crisis. While I personally don’t feel comfortable holding gold in my portfolio, I know some are convinced that it is a critical component of theirs. Until I see stronger data that backs up adding gold to my portfolio, I plan to continue investing in assets that I can properly value, like the S&P 500.

So readers, do you own gold? If so, what are your reasons for holding gold? Share your thoughts below.

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