Gold – Not So Safe after All

Following a disastrous 2008 for equities, stocks have come to be perceived as risky, volatile investments, especially for investors funding retirement accounts and other conservative portfolios. Instead of trying to find the next Google, investors have become more interested in finding safe places for their money – low-volatility, minimal-risk investments that hopefully protect against inflation. Gold has recently developed a reputation for being one of these “safe” investments after posting a comparatively fantastic +11.28% annualized return from 2000-2009, a decade during which stocks actually declined for the first time since the 1930s. Seems like gold is the place to be!

But wait one second. An historical analysis of gold returns against the S&P 500 shows that not only has gold been less profitable than stocks over the long-run – it has also been more volatile. You may be surprised to learn that gold has only outperformed stocks in three of the eleven decades since 1900, and has barely posted a positive return since 1871, with less than +0.8% annual growth, while stocks have grown +6.3% annually over the same period (both of these figures are after inflation). To get an idea of the significance of this difference, over 30 years at the above rates of return, $1,000 worth of gold would have grown to $1,266, vs. $6,252 for stocks (again, after inflation).

Until 1968, the price of gold fluctuated little owing to fixed prices and the Bretton Woods System, which held gold to a fixed price relative to the value of the US dollar, the system’s anchor currency. The system was enacted partly because the US government had nearly $26 billion in gold reserves, and by controlling the price of the commodity it virtually ensured the value of its gold would not substantially decrease. Bretton Woods eventually became unsustainable and was ended in 1968, at which point the price of gold was free to fluctuate. But in comparing returns on stocks and gold since the 1970s, a decade where gold returned an average of +16% annually after inflation, we still see a greater annualized return for stocks (+5.2%) than for gold (+4.2%) in the 40 years since 1970. The 80s and 90s saw a massive disparity between the two investments: stocks posted annualized after-inflation returns of +9.9% and +15.7% respectively over each of the two decades, while gold lost value at annualized rates of -8.2% and -5.3%. So much for hedging against inflation!

My point is not that one should only own stocks and never own gold. Nor do I necessarily disagree with analysts who project that gold will be a profitable investment over the near term. I am just using historical analysis to show that gold has been a relatively poor investment and ineffective inflation hedge over the long term, and is even more volatile and unpredictable than stocks. Its recent reputation as the perfect inflation hedge or as a “safe” investment is not deserved.

This is an illustration of how $100 would have grown over the last thirty years (click to enlarge):