GOLD as INVESTMENT

Should you be looking at gold as an investment?

"Buy land," Will Rogers advised. "They ain't making any more of the stuff."

There's something to that, actually. If people spend a constant fraction of their income on land, and the supply is fixed, over the very long run, the price of land should rise at the same rate as nominal income, or about 3% faster than inflation.

You might expect something similar to hold for gold. The metal has some unique properties that ensure that it will always be valued. However, unlike land, they are making more of the stuff-- production from mining adds to the stock by about 2% per year. That's not as fast as real economic growth, and some gold is destroyed by certain industrial uses. So one might expect gold's price also to rise a little faster than overall inflation, though perhaps not as fast as real estate.



But, as the graph from Mahalanobis at the right reveals, over the last quarter century gold hasn't even kept up with inflation; see also Division of Labor on this. Besides, other investments that appreciate with inflation also generate income for you while you're waiting for the capital gain-- real estate yields rent, corporate stocks pay dividends, inflation-indexed Treasuries give you a coupon. But gold you can only look at.

Of course, the graph also reveals that there were a few historical occasions-- the late 1970's being the most spectacular example-- in which the gold bugs were rewarded most handsomely. Historically much of the demand for gold came from its central role in monetary standards, and the roaring U.S. inflation of the late 1970's fueled a keen interest in gold as an alternative to dollars. Jewelry demand is ultimately a matter of fashion, and the idea of having jewelry that was also a store of value and inflation hedge also contributed to that price spike.


And gold prices are up 18% so far in 2005. But anyone banking on a replay of 1979 is sure to be disappointed. The surge in inflation in the 1970's had little to do with oil prices and was caused predominantly by rapid money growth. Fed Chair Paul Volcker's determination to eliminate inflation proved to be a disaster for the gold bugs. And today's Fed looks to me even more committed than Volcker was to preventing even the smallest whiff of inflation.

In any case, if you did want to bet on inflation, there are better vehicles out there for doing so, such as going short 10-year bonds and long on inflation-indexed securities.

Some investors are always going to be drawn by the allure of this pretty metal. But it's not for me.