As the war in Ukraine escalates, and the inflation threat washes over the economy, there’s a renewed interest in precious metals as an investment. But, before investors get too carried away stocking up on gold or silver bars, they should seriously consider the risks of owning precious metals and the impact on their long-term investment performance. In other words, do the benefits of owning precious metals truly outweigh the downsides of owning them?
Here are a couple of things to consider before investing in precious metals:
Precious Metals Have no Return Element
The nature of investing is that you invest in something today with the expectation you will get something back tomorrow. By definition, investing is delayed gratification—you put some money into something today, expecting to get it back in a month, a year, or ten years plus something for the amount of time you were without the money.
For example, when you invest in bonds, you can expect a certain return in the form of interest every six months for as long as you own the bond or through its maturity. Owning stocks may be more complicated in that regard, but some stocks pay a dividend, and many generate predictable profits each year, which translates into a return for shareholders. Companies have intrinsic value that can be measured based on the cash flows they are expected to generate and the shareholder value they create. Demand for a particular stock is driven by those quantifiable fundamentals.
Precious metals such as gold do not have intrinsic value, nor does it provide any cash flow or right to future earnings. There’s not even a promise of repayment at a later date. Its principal price driver is supply and demand, which is difficult to predict, and demand is driven not by fundamentals but primarily by fear.
The only thing investors in gold can count on is the hope that there will be somebody willing to pay more for it. That may be a somewhat cynical view. After all, there’s a limited supply of gold in strong demand from an emerging world, which puts natural upward pressure on its price. It’s also recognized globally as a store of value that can be traded as currency, which means it’s not likely ever to be worth zero. Regardless, there is no implicit guarantee that its price will appreciate. Owning gold in the hopes that it will appreciate is speculative at best.
Precious Metals Suck as an Inflation Hedge
But what about gold as an inflation hedge? Gold has been touted as a solid hedge against inflation forever. But, at best, its record as an inflation hedge is mixed. Though gold did come through during the inflationary 1970s, returning 35% versus an annual inflation rate of 8.8%, its record since has been dismal. From 1980 to 1984, gold returned a negative 10% against a 6.5% inflation rate. From 1988 to 1991, when the annual inflation rate was 6.5%, gold lost 7.6% for investors.
Over the last five decades, gold has had a relatively low correlation to inflation—about 0.16, where 0 means there is no relationship and 1 means they move in unison. That should tell investors worried about inflation that gold is not the best option.
Aside from real estate, the asset class that has held up the best under high inflation is large-cap, blue-chip stocks. Top brand companies with market dominance have the pricing power to grow their sales revenue and earnings faster than the rate of inflation.
How About When the “Fit hits the Shan”
Of course, owning gold for purposes of surviving in the apocalypse may be a consideration. People will always consider gold to be a store of value. But who will determine that value when you need to barter for food, clothes, or medicine? Considering that the only purpose for gold in this world is jewelry, what value would it really have when all people want is food, ammunition, and utilities. If I were to truly plan for the end of times, I would probably invest in a bunker in northeast Montana stored with three years’ worth of MREs.
