"All That Glitters May Not Be Gold"

Sydney M. Williams

Thought of the Day

“All That Glitters May Not Be Gold”

September 21, 2010

On Friday, on the day gold hit an all-time high of 1279.60, I watched Fox News’ Special Report with Brett Baier. I noted that there were four ads urging me to buy gold, one reason being “because it has never been worth zero” – not to my mind the most compelling and comforting argument for a commodity that has risen from $269.50 ten years ago to $1282.00 today – a compounded return of 16.9%. Another gold ad, this one from Rosland Capital, with G. Gordon Liddy as chief spokesman, was equally off-putting. In my mind – perhaps unfairly – Mr. Liddy is indelibly linked to President “Tricky Dick” Nixon, breaking-and-entering, and Watergate; so it is hard for me to imagine that anything Mr. Liddy wants to sell is something anybody would be willing to buy.

Gold has certainly performed well over the past ten years, but if one looked at the price of gold ten years before that – September 21, 1990 to September 21, 2000 – one would see a more dispiriting picture, as the price declined 30.8%. Thirty-nine years ago, on August 15, 1971, President Nixon removed the guarantee that the United States would honor foreign central banks’ redemption of their U.S. paper Dollars for gold at $35 per ounce. Within a month, gold was trading at $42.73 and within a year at $67.03. The price proceeded to rise sharply, driven by stagflation (a combination of low economic growth and high price inflation), until it reached $850, providing a staggering compounded annual return of 41.7%.

Bulls today, as part of their argument, cite the final surge, which carried the price up almost four fold from $230.55 on Friday, January 19, 1979 to its peak of $850.00 on Monday, January 21, 1980. They note that today’s gold price should witness a similar blow-off. They also point out that the previous peak of $850.00, on an inflation adjusted basis, would equate to $2184.00, seventy percent above today’s price. Additionally, gold bulls cite gold’s ability to protect against the dollar’s debasement, a possibility, given our enormous deficits, that has morphed into a probability. However, history shows that gold acts as a hedge some of the time, but not all the time.

Over the forty years since it began trading freely, gold has proven a valuable hedge during two of those four decades – the first and the last. The middle two decades went to stocks. Timing, as is true in so many situations, is especially critical in investing. If one had bought gold on January 19, 1979 (a year before the final blow-off) and held it through yesterday the compounded return would have been 5.7%. Of course if one had bought gold a year later on January 2, 1980 and held it through today, the price would have compounded at 2.8%, approximately off-setting the compounded annual decline of 2.6% for the U.S. Dollar.

Following forty years of a fixed price at $35.00, the untethered price of gold surged during the inflationary, unstable 1970s. It has done so again over the decade of the ‘00s – not a period of high inflation, but a time when monetary policy was easy and deficits began to build. The question for investors: will the price of gold continue to rise?

Over the years, stocks have reflected almost precisely the mirror-image return to gold. During the 1970s, while gold was levitating, stocks were sinking. As gold went into a twenty year bear market slump beginning in early 1980, and the dollar’s value shrank by about 40%, stocks gained 1170%, providing a far superior hedge. Now, after a ten year period during which stocks have lost 22% of their value, gold has appreciated 440%.

For years, an old wives tale once made the rounds, suggesting that an ounce of gold bought a decent suit. Suits have gone out of fashion and prices have sympathetically declined; so the comparison may no longer apply. (Other than weddings or funerals, for example, I rarely wear a suit.) Nevertheless, an average suit at Brooks Brothers cost about $600.00, a considerable discount to an ounce of gold.

I claim no ability to read the future. But investors should avoid the temptation to extrapolate their most recent experiences when forecasting the future trend of any commodity, be it gold or stocks. However, when a price of anything has risen as steeply as have gold prices over the past decade, coupled with Mr. G. Gordon Liddy barking abuses urging me to buy gold at today’s prices, I find comfort in procrastination.