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As per the title of this question, is gold something that can really be considered an investment or is it just a useful hedge against inflation?

While I can understand the value in having hedges against inflation, I'm at a bit of a loss over the value of having gold versus TIPS since gold has the possibility of losing value versus what I paid for while it while instruments such as the TIPS don't have that problem. Likewise, from an investment standpoint, I can see buying stock in a gold mine where I hope that it will be worth more when I sell it in inflation adjusted purchasing power.

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In a way, all equities (including stocks) are a hedge against inflation. –  JohnFx Aug 18 '11 at 16:32
    
for much of it's history, it hasn't even been an effective hedge against inflation. Unless you timed your buy extremely well, you were on an inflation adjusted basis, down more often than you were up. –  Chuck van der Linden Aug 19 '11 at 22:07
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@JohnFx But isn't the question "is gold more than just a hedge against inflation"? –  NickC Aug 23 '11 at 16:32
    
@JohnFx, Renesis - Correct, I'm interested more in if the value of gold (besides uses) is derived more from it being viewed as a hedge against inflation or if it is also viewed as a possible investment in the same way shares in a company are. –  rob Aug 23 '11 at 17:16
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7 Answers

up vote 11 down vote accepted

The problem I have with gold is that it's only worth what someone will pay you for it. To a degree that's true with any equity, but with a company there are other capital resources etc that provide a base value for the company, and generally a business model that generates income.

Gold just sits there. it doesn't make products, it doesn't perform services, you can't eat it, and the main people making money off of it are the folks charging a not insubstantial commission to sell it to you, or buy it back.

Sure it's used in small quantities for things like plating electrical contacts, dental work, shielding etc. But Industrial uses account for only 10% of consumption. Mostly it's just hoarded, either in the form of Jewelry (50%) or 'investment' (bullion/coins) 40%. Its value derives largely from rarity and other than the last few years, there's no track record of steady growth over time like the stock market or real-estate. Just look at what gold prices did between 10 to 30 years ago, I'm not sure it came anywhere near close to keeping pace with inflation during that time.

Historical gold price in USD and inflation adjusted gold price in USD. The chart shows Silver Thursday event as a peak in 1980 when Hunt brothers drove up the price of silver through speculations and after it they lost about a billion dollars.

If you look at the chart, you see a steady price until the US went off the gold standard in 1971, and rules regarding ownership and trading of gold were relaxed. There was a brief run up for a few years after that as the market 'found its level' as it were, and you really need to look from about 74 forward (which it experienced its first 'test' and demonstration of a 'supporting' price around 400/oz inflation adjusted. Then the price fluctuated largely between 800 to 400 per ounce (adjusted for inflation) for the next 30 years. (Other than a brief sympathetic 'Silver Tuesday' spike due to the Hunt Brothers manipulation of silver prices in 1980.) Not sure if there is any causality, but it is interesting to note that the recent 'runup' in price starts in 2000 at almost the same time the last country (the Swiss) went off the 'gold standard' and gold was no longer tied to any currency (or vise versa)

If you bought in '75 as a hedge against inflation, you were DOWN, as much as 50% during much of the next 33 years. If you managed to buy at a 'low' the couple of times that gold was going down and found support around 400/oz (adjusted) then you were on average up slightly as much as a little over 50% (throwing out silver Tuesday) but then from about '98 through '05 had barely broken even.

I personally view 'investments' in gold at this time as a speculation. Look at the history below, and ask yourself if buying today would more likely end up as buying in 1972 or 1975? (or gods forbid, 1980) Would you be taking advantage of a buying opportunity, or piling onto a bubble and end up buying at the high?

Note from Joe - The article Demand and Supply adds to the discussion, and supports Chuck's answer.

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You underestimate its use in modern electrical as well as decorative product. It is pounded int sheets so fine that touching it with out care will likely damage the sheet. It is called gold leaf. And the small quantities you speak of are relative. I have read its over 5 million tons a year in china and India. That is alot of gold. –  user4127 Aug 19 '11 at 14:11
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I'm familiar with gold leaf. Industrial uses of gold account for only about 10% of what is produced every year. The rest is jewelry and investment. BOTH of which are very elastic, and remain a situation of 'worth what someone will pay you for it'. A number of cultures have a long tradition of using gold as a visible expression of wealth, India is surely one of those. But seriously, in the face of a wide spread economic collapse, or runaway inflation, I think it's reasonable to expect that purchases of gold jewelry prove to be highly elastic. –  Chuck van der Linden Aug 19 '11 at 21:28
    
@Joe - OK well that is still a signifigant amount. It may have been ounces that I Read they use but that is still alot of gold. –  user4127 Aug 22 '11 at 14:26
    
Industrial use is just one use. What is the the usage of all non storage. I dont care if it is used for jewelery, industrial, or minting. Anything other that putting in a vault. –  user4127 Aug 22 '11 at 16:57
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No it was a typo, should have said 'you said 20%'. The numbers at Wikipedia, (with a footnote for the stat) Say 10%. World gold council says 11%. The stats the {USGS} (minerals.usgs.gov/ds/2005/140/gold-use.pdf) has (which only go through 2003) show demand for 'industrial' uses at less than 10% (but they break out dental as a separate stat) The USGS stats are interesting as they show industrial use actually declining –  Chuck van der Linden Aug 23 '11 at 7:25
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Gold is a commodity. It has a tracked price and can be bought and sold as such. In its physical form it represents something real of signifigant value that can be traded for currency or barted. A single pound of gold is worth about 27000 dollars. It is very valuable and it is easily transported as opposed to a car which loses value while you transport it. There are other metals that also hold value (Platinum, Silver, Copper, etc) as well as other commodities. Platinum has a higher Value to weight ratio than gold but there is less of a global quantity and the demand is not as high.

A gold mine is an investement where you hope to take out more in gold than it cost to get it out. Just like any other business. High gold prices simply lower your break even point.

TIPS protects you from inflation but does not protect you from devaluation. It also only pays the inflation rate recoginized by the Treasury. There are experts who believe that the fed has understated inflation. If these are correct then TIPS is not protecting its investors from inflation as promised.

You can also think of treasury bonds as an investment in your government. Your return will be effectively determined by how they run their business of governing. If you believe that the government is doing the right things to help promote the economy then investing in their bonds will help them to be able to continue to do so. And if consumers buy the bonds then the treasury does not have to buy any more of its own.

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"Platinum has a higher weight to value ratio than gold." Platinum trades higher per ounce than gold. "weight to value" is the reciprocal of "value per weight" or dollars per oz. Is this a typo or what you intended? The treasury's bond purchases are intended to put money into the system, people buying them actually takes money out of the system. What the economy needs is for the money to be spent and the multiplier to kick in, i.e. The velocity of money to rise. Buying treasuries is counter to this. –  JoeTaxpayer Aug 23 '11 at 0:19
    
@joe yes just had the ratio backwards. IT is the keynesian belief that putting more money out there is good for the system. The problem is government is not a profit center it is a cost center. We have the need for government to keep things stable and secure. If government can do that then business feels confident in investing in itself. When government starts shaking things up business stops investing because there are too many unknowns. It waits for things to settle down and reevaluates. So while the government trys to make moves the economy stops to wait for it to settle. –  user4127 Aug 23 '11 at 13:58
    
ok, good edit. I didn't want to edit till I was sure what you meant. –  JoeTaxpayer Aug 23 '11 at 16:10
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Another answer to this question occurred to me as I started learning more about historical uses for gold etc. Perhaps it's a crackpot idea, but I'm going to float it anyway to see what you folks think.

Investing in Gold is an indirect investment in the Economy and GDP of the nation of India. To that extent is it only a hedge against inflation, so long as the indian economy grows at a more rapid rate than your local inflation rate.

Fact, India currently consumes more than 1/3 of gold production, predominantly in the form of Jewelry. And their demand has been growing rapidly, up 69% just between 2009 and 2010 alone. I can't find too many historial consumption numbers for India, but when you look at past articles on this subject, you see phrases like 'one forth' and '20%' being used only a few years go to describe India's consumption levels.

Fact, India has virtually no domestic sources of gold. India’s handful of gold mines produce about 2.5 tonnes of the metal each year, a fraction of the country’s annual consumption of about 800 tonnes.

Fact. Indian Culture places high value on gold as a visible demonstration of wealth. Particularly in situations such In Indian weddings where the bride brings in gold to show her family's status and wealth and it forms part of the dowry given to bride. It is believed that a bride wearing 24k gold on their wedding to bring luck and happiness throughout the married life.

Fact, the recent trends in outsourcing, Indian citizens working abroad sending money home, etc have all lead to a influx of foreign cash to the Indian economy and explosive GDP growth. See the following chart and compare the period of 2000-current with a chart showing the price of gold in other answer here. Notice how the curves parallel each other to a large degree

enter image description here

Potentially unfounded conclusion drawn from above numbers. The rapid growth of the Indian economy, coupled with a rich cultural tradition that values gold as a symbol of wealth, along with a sudden rise in 'wealthy' people due to the economy and influx of foreign cash, has resulted in skyrocketing demand for gold from India, and this large 'consumption' demand is the most likely explanation for the sudden rise in the price of gold over the last several years. Investors then jump on the 'rising price bandwagon' as especially does anyone that can make a profit from selling gold to those seeking to get on said bandwagon.

As such, as long as indian cultural tradition remains unchanged, and their economy remains strong, the resulting increasing demand for gold will sustain current and perhaps increased prices. Should there be any sudden collapse in the Indian GDP, gold will likely tumble in parallel.

disclaimer: not an expert, just observations based off the data I've seen, there may be other parts to the picture of 'gold demand' that I've not considered.

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+1: Clever explanation, crackpot or not. A suggestion: Buying gold actually works against the Indian economy by forcing them to outbid you; you aren't investing in the Indian economy so much as placing a bet that the Indian economy will keep growing, and those are subtly different positions. Also, I'd add the gold graph right next to the Indian GDP graph, to aid in direct comparison. –  jprete Aug 25 '11 at 17:44
    
The consuption price increase would hold water if the consumption reduced as the price went up. However since the consumption continues to increase even as the price goes up leads me to think that while they may provide some upward pressure I doubt they are the only reason gold is increasing in value. –  user4127 Aug 25 '11 at 18:14
    
If you consider the strong cultural pressure (now it just shows you are even MORE wealthy) combined with the sense that due to high price it's a good investment (it is also treated almost like money) , then we might not expect much of a change. Also the gold curve lags behind, so that could explain it also.. Indian GDP takes off in about 80-90 gold doesn't soar till post 2005, during the steepest part of the GDP growth. –  Chuck van der Linden Aug 25 '11 at 20:45
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Over on Quantitative Finance Stack Exchange, I asked and answered a more technical and broader version of this question, Should the average investor hold commodities as part of a broadly diversified portfolio? In short, I believe the answer to your question is that gold is neither an investment nor a hedge against inflation.

Although many studies claim that commodities (such as gold) do offer some diversification benefit, the most credible academic study I have seen to date, Should Investors Include Commodities in Their Portfolios After All? New Evidence, shows that a mean-variance investor would not want to allocate any of their portfolio to commodities (this would include gold, presumably).

Nevertheless, many asset managers, such as PIMCO, offer funds that are marketed as "real return" or "inflation-managed" and include commodities (including gold) in their portfolios. PIMCO has also commissioned some research, Strategic Asset Allocation and Commodities, claiming that holding some commodities offers both diversification and inflation hedging benefits.

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Gold is not an investment. Gold is a form of money. It and silver have been used as money much longer than paper. Paper money is a relatively recent invention (less than 350 years old) with a horrible track record of preserving wealth. When I exchange my paper US dollars for gold I'm exchanging one form of money for another. US dollars, or US Federal Reserve Notes to be more precise, can be printed ad nauseam by one bank that is totally private and is never audited. Keeping all of your savings in US dollars is ignoring history, it is believing the US Federal Reserve has your best interest in mind, it is hoping that somehow things will be different this time, it is believing that the US dollar will somehow magically be the first fiat currency to last a person's lifetime.

TIPS may seem like a good hedge against inflation. However, the government offering TIPS is also the same government that is calculating the inflation rate used to adjust TIPS. What a great deal. If you do some research you discover that the method for calculating the consumer price index is always "modified" since it is always found to over estimate inflation. It is never found to under estimate inflation. Imagine that. Here is a chart showing the inflation rate as if it were calculated the same way as it was calculated in 1980.

Buying any government debt is also a way to guarantee you or your children will be taxed in the future since the government will have to obtain the money from someone to pay back bonds. It's like voting for future taxes.

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Nickels and booze on the other hand . . . –  Pete Aug 22 '11 at 21:01
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Booze would be my preferred way to hedge against a failing currency but my wife is not confident that I wouldn't drink all the money :) –  Muro Aug 23 '11 at 0:57
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From Wikipedia:

Investment has different meanings in finance and economics. In Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time. In contrast putting money into something with an expectation of gain without thorough analysis, without security of principal, and without security of return is speculation or gambling.

The second part of the question can be addressed by analyzing the change in gold price vs inflation year by year over the long term. As Chuck mentioned, there are periods in which it didn't exceed inflation. More important, over any sufficiently long length of time the US stock market will outperform. Those who bought at the '87 peak aren't doing too bad, yet those who bought in the last gold bubble haven't kept up with inflation. $850 put into gold at the '80 top would inflate today to $2220 per the inflation calculator. You can find with a bit of charting some periods where gold outpaced inflation, and some where it missed.

Back to the definition of investment. I think gold fits speculation far better than it does investment. I've heard the word used in ways I'd disagree with, spend what you will on the shoes, but no, they aren't an investment, I tell my wife. The treadmill purchase may improve my health, and people may use the word colloquially, but it's not an investment.

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+1 I agree that gold itself is not really an investment. But that does not mean that it is just a hedge against inflation. You can use gold as an investment or as a hedge. But it is not really either one. –  user4127 Aug 25 '11 at 18:20
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Over time, gold has mainly a hedge against inflation, based on its scarcity value. That is, unless finds some "killer app" for it that would also make it a good investment. The "usual" ones, metallurgical, electronic, medicine, dental, don't really do the trick.

It should be noted that gold performs its inflation hedge function over a long period of time, say $50-$100 years.

Over shorter periods of time, it will spike for other reasons. The latest classic example was in 1979-80, and the main reason, in my opinion, was the Iranian hostage crisis (inflation was secondary.) This was a POLITICAL risk situation, but one that was not unwarranted. An attack on 52 U.S. hostages (diplomats, no less), was potenially an attack on the U.S. dollar. But gold got so pricey that it lost its "inflation hedge" function for some two decades (until about 2000).

Inflation has not been a notable factor in 2011. But Mideastern political risk has been. Witness Egypt, Libya, and potentially Syria and other countries.

Put another way, gold is less of an investment that a "hedge." And not just against inflation.

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