August 16, 2014

Are Gold ETFs an Overrated Investment?

The SPDR Gold Shares ETF (GLD) currently has over $33.5 billion in assets. The iShares Gold Trust (IAU) has nearly another $7 billion. Impressive in their own right, these numbers are probably insignificant in comparison with the amount of physical gold held by individual investors, governments, and businesses around the word for investment purposes. Clearly there are tons of people who love the stuff.

But why? Is it because investors have short-term memories and have forgotten everything that happened to gold prices more than 10 years ago? We often hear about how gold is a "safe" investment compared to those speculative, volatile stocks. We often hear about how gold is the best hedge against inflation. I beg to differ.

That is one huge gold nugget!I prefer to make investments based on the income-generating potential whatever assets I'm buying. When I invest in a broad index of public companies, I'm investing in entities that actually create value. These companies are run by people trying to make the most profit possible, and they're filled with people who do real things and create real value in the world. But gold is just a commodity. If I buy a gold bar today and throw it in a safe, it just sits there. Doing absolutely nothing. Creating absolutely no value. I'm just betting that someone in the future will pay me more than I paid for it based on supply and demand. It's useful in jewelry-making and in other applications on a limited scale. But for the most part it's only valuable because people think it is, not because of some intrinsic value. Other commodities, like oil, are essential to the day-to-day functioning of human civilization. If all the gold in the world disappeared tomorrow, a lot of people would be bummed, but essential services, products, and public functions would probably pretty easily find better replacements. So how on earth is gold safer than equities? When I buy equities, I'm betting on the continued ingenuity of humans to create new ways of doing things and find ways to make more money. To me, that's far safer than buy a pretty shiny metal.

But isn't gold a better hedge against inflation?
No! Stocks are! Check out this piece by the Washington Post supporting the claim that stock returns are essentially unaffected by inflation over time. And since owning stocks means owning real companies, those companies own real assets that also increase with inflation. Meanwhile, through the 80s and 90s the inflation rate was 3.9% yet gold lost 85% of its real purchasing power by 2002 (in just over 20 years). Forbes even goes as far to claim that, "returns from gold appear to have no clear relationship to inflation."

And mostly, I don't want to sink money into an asset that's been known to flat-line for decades in a row. Nearly all of gold's recent outperformance was due to an unprecedented run-up beginning roughly in 2006 and continuing into 2011. Once those good times ended and equities got back on track, gold experienced a trouncing of epic proportions as stocks have marched onto new highs.

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