Gold and unrealistic expectations – Gold is not an investment

Gold has been characterized as insurancea hedge against inflation/social unrest/instability, or more simply, just a commonplace. But it is usually treated as one by most people investment.

This even applies to those who are more negative in their attitude towards gold. “Stocks are a better investment.” In most cases, the logic used and the performance results justify the statement. But the premise is wrong. Gold is not an investment.

When gold is analyzed as an investment, it is compared to a variety of other investments. And then the technicians start looking for correlations. Some say that an ‘investment’ in gold is inversely related to stocks. But there have been periods when both stocks and gold went up or down at the same time.

One of the often-touted “negative” features of gold is that it does not pay dividends. This is often cited by financial advisors and investors as a reason not to own gold. But then…

Growth stocks do not pay dividends. When was the last time your broker advised you to stay away from stocks because they don’t pay dividends. A dividend is NOT extra income. It is a fractional liquidation and payout of a portion of the value of your shares based on the specific price at that time. The price of your share will then be adjusted downwards by the exact amount of your dividend. If you need income, you can periodically sell some of your gold or your shares. In both cases, the procedure is called “systematic admissions.”

The (il)logic continues… “Because gold does not pay interest or dividends, it struggles to compete with other investments that do.” Essentially, higher interest rates lead to lower gold prices. And conversely, lower interest rates correlate with higher gold prices.

The above statement, or a variant thereof, appears (almost) daily in the financial press. This also applies to respected publications such as the Wall Street Journal. Since the US election last November, it has appeared several times in one context or another.

The claim – and any variation of it implying a correlation between gold and interest rates – is false. There is no correlation (inverse or otherwise) between gold and interest rates.

We know that when interest rates rise, bond prices fall. So another way of saying that gold will suffer if interest rates rise is that if bond prices fall, so will gold. In other words, gold and bond prices are positively correlated; gold and interest are inversely correlated.

Except during the 1970s – as interest rates rose rapidly and bond prices fell – gold went from $42 an ounce to $850 an ounce in 1980. This is the exact opposite of what we would expect according to the correlation theory cited earlier and often written about by those who are supposed to know.

During 2000-11, gold rose from $260 an ounce to a high of $1900 an ounce, while interest rates fell from historically low levels to even lower levels.

Two separate decades with significantly higher gold prices that contradict each other according to the interest rate correlation theory.

And the conflicts continue as we see what happened after gold peaked in both cases. Interest rates continued to rise for several years after gold peaked in 1980. And interest rates have continued their protracted decline, even crossing negative integers recently, six years after gold peaked in 2011.

People also talk about gold the way they talk about stocks and other investments… “Are you bullish or bearish?” “Gold will explode higher if/when…” “Gold collapsed today if…” “If things are so bad, why won’t gold react?” “Gold is marking time, consolidating its recent gains…” “We are fully invested in gold.”

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When gold is characterized as an investment, the incorrect assumption leads to unexpected results, regardless of logic. If the premise is wrong, even the best, most technically perfect logic will not lead to consistent results.

And invariably the expectations (as unrealistic as they are) associated with gold, as with everything else today, are incessantly short-lived. “Don’t confuse me with the facts, man. Just tell me how fast I can double my money.”

People want to own things because they expect/want the price of those things to go up. That’s reasonable. But the higher stock prices we expect or have seen in the past represent valuations of a greater quantity of goods and services and productive contributions to overall quality of life. And that takes time.

Time is of the essence for most of us. And it seems to be increasingly overshadowing everything else. We don’t take the time to understand the basics. Just get to the point.

Time is just as important to understanding gold. In addition to understanding the basics of gold, we need to know how time affects gold. More specifically, and to be technically correct, we need to understand what has happened to the US dollar over time (the past hundred years).

Over five thousand years of recorded history, many things have been used as money. Only one has stood the test of time – GOLD. And its role as money was established through its practical and convenient use over time.

Gold is originally money. Paper currencies are substitutes for real money. The US dollar has lost 98 percent of its value (purchasing power) over the past century. That fall in value coincides in time with the existence of the US Federal Reserve Bank (since 1913) and is the direct result of the Federal Reserve’s policies.

The gold price in US dollars is a direct reflection of the deterioration of the US dollar. Nothing anymore. Nothing less.

Gold is stable. It’s constant. And it’s real money. Since gold is priced in US dollars and since the US dollar is in constant decline, the price of gold in US dollars will continue to rise over time.

There are constant subjective, time-to-time changing valuations of the US dollar and these changing valuations are reflected in the constantly fluctuating value of gold in US dollars. But at the end of the day, what really matters is what you can buy with your dollars, which gets less and less over time. What you can buy with an ounce of gold remains stable, or better.

When gold is characterized as an investment, people buy (‘invest’ in) it with the expectation that it will “do something”. But they will probably be disappointed.

In the late 1990s there was much speculation about the possible effects on gold of the approaching Gulf War. There were some price increases and fears mounted as the target date for ‘action’ approached. Almost simultaneously with the beginning of bombardments by US troops, gold retreated sharply, giving up its previously accumulated price gains and even going lower.

Most observers describe this turnaround as somewhat surprising. They attribute it to the swift and decisive action of our forces and the results achieved. That’s a helpful explanation, but not necessarily an accurate one.

Most important for gold was the impact of the war on the value of the US dollar. Even a long-term involvement would not necessarily have undermined the relative strength of the US dollar.

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The value of gold is not determined by world events, political unrest or industrial demand. All you need to know to understand and appreciate gold for what it is is to know and understand what is happening to the US dollar.