All That Glitters is Not Gold

With a seemingly endless supply of ominous global economic news, investing in gold has grabbed much of the media’s and investors’ attention.  Many investors have become mesmerized by the luster of profit and safety.  But are the touted expectations too lofty, only a sales pitch, pure sensationalism or are they reasonable?  What are the risks and rewards associated with gold investments?  Our intention here is to provide an unbiased perspective on gold built on an analysis of actual performance. The goal is to help manage expectations and to provide insight allowing investors to decide if gold is a worthy participant in a diversified portfolio

Gold as a total return investment.  Since the early 1970s when the United States dollar left the gold standard, gold has provided investors significant return.  Since August, 1971, when President Nixon ended the direct convertibility of dollars into gold, the price of gold has appreciated from $42.73 to $1,560.43 per ounce (as of 5/31/2012).  The appreciation is equivalent to a 9.2 percent annual return.  Not bad considering the S&P 500 appreciated 6.5 percent (annualized return, not including dividends) and inflation (CPI-Urban Consumer) was effectively 4.3 percent over the same time period.  How dependable are these historical returns when viewed by a potential gold investor?

Since gold has very limited real economic value/demand (except for jewelry and very few industrial applications), its price is largely driven by speculation and fear.  Historically, large price appreciations were associated with fears of high inflation, a declining dollar or stressed market conditions.  Once these fears subside, even modestly, the price of gold could plummet abruptly, as it often has.  Consider the following data:

Historical Price of Gold – The Ups and Downs1

Dates Number of Months Price Appreciation Dates Number of Months Price Decline
8/27/76 – 1/21/80 40.7 717.3% 1/21/80 – 3/18/80 1.9 -43.4%
6/21/82 – 2/15/83 7.9 71.6% 2/15/83 – 2/25/85 24.3 -44.2%
7/2/85  – 12/14/87 29.4 62.1% 12/14/87 – 6/14/90 30.0 -30.8%
3/9/93 – 2/2/96 34.8 26.7% 2/2/96 – 8/25/99 42.7 -39.2%
6/1/05 – 5/12/06 11.3 72.1% 5/12/06 – 6/14/06 1.1 -21.7%
8/16/07 – 3/14/08 6.9 53.8% 3/14/08 – 11/12/08 8.0 -29.0%

If an investor was fortunate—or lucky enough—to time the gold market perfectly, he/she could have achieved impressive returns.  Caution!  As the preceding table illustrates, each run-up was followed by a significant decline. Unfortunately, many investors buy gold far too late into its ascent, fail to achieve the outsized returns, and then fall victim to the sharp decline.

It is true that long-term investors (over 40 years) would have enjoyed a very respectable return.  However, the journey was far from smooth. Even when compared to the stock market, gold has been more risky.  For example, the volatility of gold since August, 1971, has been 30 percent higher than that of the S&P 500 price index.  Additionally, the maximum draw down (potential compounded loss) was much larger as well, -61.7 percent versus -52.6 percent respectively.

Gold as an inflation hedge.  For many investors, it has been a foregone conclusion that gold is a good inflation hedge.  And during many periods in the past, gold performed exceedingly well when the fear and realized inflation were high. For example, in the mid to late 1970s, gold reached levels of annual appreciation of 30 to 150 percent when inflation reached close to 15 percent. However, what isn’t widely known is that since 1971, gold’s price appreciation beat inflation (U.S. CPI Urban Consumers) only 55 percent of the time (in any 12-month period).  In other words, more than four out of 10 years, an investment in gold would have lost investors’ purchasing power.

The following chart demonstrates how gold has underperformed inflation for an extended period of time.  It shows how the value of $100 dollars invested in gold would have performed versus $100 (as of 1980) appreciating at the rate of inflation.  The beginning of the chart was the peak gold price in early 1980 (record high at that time


Amazingly, even though gold has performed remarkably since mid-2001, it has yet to catch up with the $100 adjusted for inflation since 1980.

Gold in a diversified portfolio.  Another widely believed ‘truth’ about gold is that it will provide an investor’s portfolio sharp positive returns if the capital markets are stressed.  Similar to gold’s inflation protection, gold does indeed provide diversifying qualities on occasion.  But there have been many occasions in the past where it unquestionably did not provide diversifying support.

For example, in those months when the S&P 500 lost more than 5 percent (considered ‘stressed’ for this discussion), gold provided a positive return on average (+1.6 percent).  Unfortunately, gold produced positive returns in stressed equity markets only two-thirds of the time.  The other third of the time gold also lost money (with the S&P 500).  A recent example is the period from March, 2008, (Bear Stearns collapse) through late fall of 2008 (Lehman and credit market debacle).  The following chart shows the compounded loss of the S&P 500 as compared with the compounded loss of gold.


In today’s environment, gold could very possibly provide an investor a phenomenal return if the global capital markets experience extreme turbulence and losses (e.g. collapse of the dollar).  This would suggest that the remaining assets in the investor’s portfolio will likely decline very dramatically.  To offset these losses, the necessary allocation to gold would have to be very large—imprudently large.  A portfolio grossly over weighted in any asset class or strategy is exposed to a tremendous amount of risk and/or under performance.  This is especially true of investments that historically have been highly volatile.

Conclusion.  In the past, investing in gold has provided investors outstanding results—at times.  Unfortunately, it has also damaged fearful investors permanently.  It is our belief that a truly diversified portfolio is the best weapon for defending against known and unknown market risks, and increases investors’ odds of reaching their desired financial destination.  Anxiety and fear of what is possible, rather than what is probable, can be paralyzing and, in the long-run, very crippling to one’s financial security.

Christopher Jordan, CFA, CAIA, FRM
Director of Alternative Investments
Moneta Group

A client’s investment return may be lower or higher than the performance shown in this paper. Clients may suffer an investment loss by investing in alternative investments.

Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express of implied, is made regarding future performance.

This report has been prepared for the exclusive use of MGIA and its clients. MGIA is not responsible for any use of this report to any other than those for whom it was intended.

The information contained herein has been prepared from sources believed to be reliable but MGIA makes no representations as to their accuracy or completeness. This report is provided to you for information purposes only and should not be considered as an offer or solicitation to buy, sell or subscribe to securities or other financial instruments. The opinion expressed is subject to change without notice and should not be relied upon in substitution for the exercise of independent judgment.

Alternative investments are often complex investments, typically involve a high degree of risk and are intended for sale only to sophisticated investors capable of understanding and assuming the risks involved. The market value of any alternative investment may be affected by changes in economic, financial and political factors, time to maturity, market conditions and volatility, and credit quality of any issuer or reference issuer. Any client interested in purchasing an alternative investment product should conduct their own investigation and analysis of the product.


1Source: Bloomberg, Gold spot price as US Dollar per Troy ounce

Additional articles