Over the past two years, I’ve received a lot of requests to write about investing in gold and silver. I’ve ignored these requests. For one, I feel unqualified to comment. For another, I’m afraid that anything I do say will just make people angry.

Last week I realized, however, that I don’t have to come at this as an expert. Because I’m not one. Instead, maybe we can have a discussion about the pros and cons of investing in gold while using my own opinion as a starting point. (And note that this article contains my opinion. It’s backed up by some facts, but it’s still my opinion. Don’t take everything that follows as gospel.)

Put simply: I’m not a fan of precious metals. I have 0% of my investment dollars in gold and silver, and I expect that to hold true for the foreseeable future. It’s my opinion that gold is a bad investment right now. Let me explain my reasoning.

Note: To make things easier for the rest of this article, I’m just going to talk about investing in gold. That’s what most people mean when they talk about precious metals, anyhow.

The Gold Standard
Many folks dislike our current monetary system because it’s based on fiat currency. That is, a dollar is worth an arbitrary amount because the government says so. It’s not based on anything concrete. Plus, the government can add and remove cash from the money supply at will, which affects the dollar’s value.

U.S. dollars — and other world currencies — were once backed by gold. Under the Gold Standard, you could ask a bank to convert your paper money to gold at the legal rate (whatever that might be). In order for the government to print more money, they had to have the gold to back it.

Proponents of the “Gold Standard” argue that since the U.S. abandoned it in 1933, the dollar is more susceptible to inflation. That’s true. But the Gold Standard didn’t eliminate inflation, and it created other problems besides.

I am not an economist, and I struggle when it comes to economic theory, but my understanding is that much of the run-up to and aftermath of the Great Depression was thought to have been caused by the Gold Standard. Under the Gold Standard, currencies were much more susceptible to speculation and devaluation, which could lead to runs on the banks. That’s why the U.S. abandoned it. And it wasn’t only the United States that did so. Not a single country in the world uses the Gold Standard anymore. Until recently, most economists and politicians considered it a deserved relic.

Note: Though it’s long, this 2004 speech from Ben Bernanke about money, gold, and the Great Depression is interesting, and explains why we’re not likely to ever return to a Gold Standard in the U.S. — at least not while Bernanke is in charge of monetary policy.

Defense Against Disaster
Some proponents of gold like it because they say it has intrinsic value. That is, they say that gold has value in and of itself. (Kevin McElroy does a good job explaining this concept at The Street.)

Goldbugs would have you believe that when diaster strikes — we enter a post-oil economy, we’re nuked by terrorists, dinosaurs escape from Isla Nublar — that paper money will be worthless and we’ll all be trading in gold. Because of its intrinsic value, it’ll become a form of currency. I’m not convinced.

Let’s say I’m a shopkeeper. I have a minimart and I have a shotgun to defend my stock from looters. If we’re in some sort of post-crisis world where dinosaurs roam the earth, I doubt I’ll want your gold. It’ll be just as worthless (or as valuable) as paper money. Why? Because in reality, gold too is fundamentally a fiat currency. That is, people have assigned it an arbitrary value. That value vanishes in a crisis, just as the value of paper money does.

If I’m a shop owner in this situation — or I’m your neighbor with a vegetable garden — I’m going to be want to be paid with something real, something like a carton of eggs or some shells for my shotgun.

In other words, I don’t think much of gold’s intrinsic value. To me, assigning value to gold is just as arbitrary as assigning value to anything else. If we’re in a real crisis, I’m not convinced that gold’s going to save the day. (Again, this is my opinion. You may disagree.)

Tip: For a more coherent and educated take on this subject, read this essay on why gold does not have intrinsic value.

My first two objections to owning gold are based purely on theory. Nobody knows for sure what would happen if we returned to the Gold Standard. If dinosaurs roamed the earth, we’d have more important things to worry about than the form of our currency. But I have other, more concrete objections to investing in gold right now.

The Gold Bubble
As I write this, gold is hovering at about $1500 per ounce, which is just off its April high of $1550 per ounce. But that’s not only its April high; that’s an all-time high for the stuff. (As near as I can calculate, gold’s inflation-adjusted high was about $2500 per ounce back in 1973.)

Gold bottomed out in 1999 at $252.80 (an inflation-adjusted $327.61). Since then, the gains have been impressive, with returns of over 20% nearly every year. Great! We should all jump in and buy, right? Well, I’m not so sure.

Let’s think for a moment. Have we seen any price bubbles before? Maybe even in recent history? Over the past fifteen years, we’ve seen three bubble economies:

  • First, the boom in tech stocks in the late 1990s.
  • Then the run-up of housing prices in the early 2000s.
  • Finally, the second stock market bubble in the middle of the last decade.

During these bubbles, the proponents of each investment made compelling cases for why “this time is different!” More people bought stocks and homes, which drove prices up, which made the investments look more appealing, which meant more people bought, which drove prices up until…

The bubble burst.

The bubble always bursts.

During the bubble, there are plenty of snake-oil salesmen with silvery tongues who will try to convince you that this isn’t actually a bubble, that this is where prices are meant to be. Many of these people actually believe what they say. (Though, to be clear, some don’t. Some know exactly what they’re doing.)

After the bubble, there are a lot of people wondering what happened to their wealth.

Right now, the price of gold is high because the demand for gold is high. Over the past decade, our country’s economic policies have created a fear of the future, which means many people are clinging to gold as a sort of insurance. Gold prices are rising. How high will they go? Peter Schiff thinks that gold will hit $5000 an ounce. I’m skeptical. I think gold is more likely to see $500 an ounce in the next decade than $5000 an ounce.

But, hey — I could be wrong. Maybe the gold bubble isn’t a bubble. Maybe prices won’t come crashing down as they did for real estate and stocks. You need to decide that for yourself. Right now, I’m willing to bet on the side of history.

Bonus!

You have no idea how much work goes into a post like this. I do hours of research and write thousands of words before cutting back to the essentials. And with topics involving lots of data, I go down all sorts of rabbit holes while playing with numbers.

For instance, on a whim, I decided to check the effect of the last few Presidential administrations on the price of gold. This is mostly meaningless, but it’s still interesting to see.

Inauguration Gold price President Change
01/20/77 $133.10 Carter +322%
01/20/81 $562.00 Reagan -28%
01/20/89 $405.50 H.W. Bush -19%
01/20/93 $329.00 Clinton -20%
01/20/01 $264.00 W. Bush +223%
01/20/09 $853.25 Obama +76%
05/09/11 $1502.00  

The Carter numbers are odd. Nearly all of that 322% increase came during the last few months of his administration. Again, I’m not saying this data has any meaning. I just find it fascinating. If you want to fritter away time by playing with numbers, you may find this page of daily gold prices handy.

(And that’s an hour of my time wasted that could have been used to write another article about clipping coupons or budgeting.)

The Path of History
For me, though, the most compelling case against investing in gold can be found in the historical record. Goldbugs like to praise the stuff because it’s a “hedge against inflation”. Gold tends to retain its value as prices rise. That’s true — but long term, that’s all that it does.

There are other things that tend to keep their value during inflation, if that’s what you want. Real estate, for one. And TIPS (treasury inflation protected securities, a type of bond). And maybe even savings accounts.

If you’re wanting to fight inflation, there are better options. In his book Stocks for the Long Run, Jeremy Siegel crunched the numbers to find the historical performance of several common investments. The results? Since 1926:

  • Gold has a real return (meaning: “after-inflation return”) of about 1%.
  • By my calculations (not Siegel’s), real estate also has a real return of about 1%.
  • Bonds have returned about 5%, or about 2.4% after inflation.
  • Stocks have returned an average of about 10% per year, and a real return of about 6.8%.

So, if you want to use gold as a hedge against inflation, go ahead. But real estate might be just as effective — and that bubble has popped already. Of course, past returns are no guarantee of future results. Perhaps over the next thirty years, gold will average an annual return of 6.8% and stocks an average return of 1%. Nobody knows for sure.

Note: I can’t find any data on the relationship between savings-account interest and inflation. If I had to make an educated guess, I’d say that savings accounts return about 1% more than inflation every year, meaning that they’re on a par with gold or real estate in the long term. But this is just a guess!

Before I leave this section, I want to share a quote from Siegel’s Stocks for the Long Run:

Ironically, despite the inflationary basis of a paper money system, well-preserved paper money from the early nineteenth century is worth many times its face value on the collectors’ market, far surpassing gold bullion as a long-term investment. An old mattress found containing nineteenth-century paper money is a better find for an antiquarian than an equivalent sum hoarded in gold bars!

There’s no real take-away from that, I suppose. It’s just funny.

Personal Experience
You might think that the current gold fever is the first of its kind. Actually, it’s not. Gold fever seems to strike every 20-30 years, whenever there’s a run-up in prices. The last time I remember it was when I was a boy.

My father became a goldbug during the economic crisis of the late seventies and early eighties. He was convinced gold prices were going to soar permanently. The things he said then are just like the things I hear the goldbugs saying today. It’s like history repeating itself. Though he could barely afford to put food on the table, during 1980 Dad found a way to buy ten gold coins at roughly $500 each. (Plus whatever commission he paid.) He loved to show them to us kids: “Look at my pretty pieces of metal.” Dad had no savings or investments, so these coins were his nest egg.

The eggs turned out to be rotten.

As I recall, Dad sold a few of the coins almost immediately because we needed the money to buy food and clothing. No worries. The price of gold had risen, so he made a little profit. But he held the rest of his “pretty pieces of metal” until the mid 1980s, when he decided to start the custom box company. Then he sold the coins for just over $300 an ounce. He lost about a thousand dollars on what he thought was a sure thing. The sure thing turned out to be a bubble.

Further reading

Fore more interesting stories about investing in gold, check out:

If you know of good articles about investing in gold, please share them in the comments.

Draw Your Own Conclusions
For all of these reasons, I’m not investing in gold. Not right now. Not at these prices. Does that mean you should avoid investing in gold? Not at all. It means you should do your own reading and research and find out what the best decision is for you. Don’t just take my word for it, but don’t be persuaded by a bunch of ads on radio or TV, either.

Whether you’re for or against gold as an investment option, I encourage you to read rational, well-written articles from the other side. Try to figure out where they’re coming from. Does the opposition make some good points? After reading another opinion, do you think there might be times that you could see their point of view?

In my case, I’m not completely against investing in gold. In fact, I’m persuaded that it generally makes sense to have some in your investment portfolio as part of a strategy of diversification. In time, I plan to add a little. Eventually. (But not now, not when prices are at record highs.) However, with one exception — see the sidebar below — I can’t imagine ever devoting more than five percent of my portfolio to the stuff. (And even that seems high.)

My opinion is that we really are in a gold bubble, and that the bubble will eventually burst. When it does, I’ll buy a bit of gold. Until then, I’m happy to watch the roller coaster ride from the outside.

The Permanent Portfolio

One investment strategy that I find appealing uses a lot of gold. This is the permanent portfolio, as developed by Harry Browne. The permanent portfolio calls for a fixed asset allocation:

  • 25% in U.S. stocks, to provide a strong return during times of prosperity
  • 25% in long-term U.S. Treasury bonds, which do well during prosperity and deflation
  • 25% in cash (a money-market fund) to hedge against recession
  • 25% in gold to provide protection during periods of inflation

If I were to choose any other investment plan than the one I have, it’d be this one. I find the arguments compelling, and wouldn’t be surprised if five years from now, I’d adopted this strategy.

For more on the permanent portfolio — including how to invest in gold — visit Crawling Road.

Reminder: This is another one of those topics that tends to inspire passionate debate. It’s fine to disagree with each other (and with me), but please keep it civil. Sound fair?

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