Let’s Be Honest About Gold: It’s a Pet Rock
12:13 pm ET
Jul 17, 2015
Let’s Be Honest About Gold: It’s a Pet Rock
http://si.wsj.net/public/resources/i...0715113209.jpgChristophe Vorlet
Gold is supposed to be a haven amid hard times and soft money. So why, even as Greece has defaulted, the euro has sunk against the dollar, and the Chinese stock market has stumbled, has gold been sitting there like a pet rock?
Trading this week below $1,150 an ounce, the yellow metal has fallen more than 39% since it peaked at nearly $1,900 in August 2011. Since June 2014, investors have yanked $3 billion out of funds investing in precious metals, estimates Morningstar, the financial-research firm; total assets at precious-metal funds have shrunk 20% in 12 months.
“A lot of investors have become disillusioned with gold,” says Suki Cooper, head of metals research at Barclays in New York. “Safe-haven demand hasn’t been strong enough to lift prices, but has only been strong enough to keep them from falling.”
Many people may have bought gold for the wrong reasons: because of its glittering 18.7% average annual return between 2002 and 2011, because of its purportedly magical inflation-fighting properties, because it is supposed to shine in the darkest of days. But gold’s long-term returns are muted, it isn’t a panacea for inflation, and it does well in response to unexpected crises—but not long-simmering troubles like the Greek situation. And you will put lightning in a bottle before you figure out what gold is really worth.
With greenhorns in gold starting to figure all this out, the price has gotten tarnished. It is time to call owning gold what it is: an act of faith. As the Epistle to the Hebrews defined it forevermore, “Faith is the substance of things hoped for, the evidence of things not seen.” Own gold if you feel you must, but admit honestly that you are relying on hope and imagination.
Recognize, too, that gold bugs—the people who believe in owning the yellow metal no matter what—often resemble the subjects of a laboratory experiment on the psychology of cognitive dissonance.
When you are in the grip of cognitive dissonance, anything that could be regarded as evidence that you might be wrong becomes proof that you must be right. If, for instance, massive money-printing by central banks hasn’t ignited apocalyptic inflation, that doesn’t mean it won’t. That means it is more likely than ever to happen—someday.
You don’t want to be one of these people, spending years telling reality that it is wrong. There is a case to be made for owning gold, but it speaks in a whisper, not in the shouts of doomsday so customary among gold bugs.
Because gold, unlike stocks, bonds, real estate and other financial assets, generates no income, valuing it is all but impossible. “It’s intrinsically worthless or intrinsically priceless,” says Paul Brodsky, a former hedge-fund manager who now is a strategist at Macro Allocation, an investment-research and consulting firm in New York. “You can build a financial model to value it, but every input is going to be your imagination.”
Gold is two things, neither of which is easy to price: a commodity and a currency.
First, the commodity: At recent prices, mining companies are losing money on more than an eighth of the gold they dig out of the ground, says Ms. Cooper of Barclays. That could lead to a decline in supply. And if demand—even from noninvestment buyers like consumers in China or India—rises unexpectedly, there might not be enough gold to go around.
William Rhind, chief executive of World Gold Trust Services, sponsor of SPDR Gold Shares, an exchange-traded fund with $26 billion in assets, also foresees what he calls “a continuing shift in demand from West to East, and from investors to consumers.”
Those factors, Ms. Cooper says, suggest that gold is unlikely to slide much lower and could eventually go quite a bit higher.
When? How much? Who knows?
As a currency, gold has a latent and indeterminate value, Mr. Brodsky says. If the world goes to financial hell in a handbasket, you wouldn’t lug gold ingots to the supermarket so you could stock up on canned goods. But you might pay for those goods with dollars that are again backed with gold, as they were until 1971.
The metal is “cumbersome and archaic and barbaric,” Mr. Brodsky says, “but it remains a store of value, and gold might be called upon again to be the basis for money, as a real backing of currency.” Basing the value of their money on something scarce, rather than the unrestricted right to run the printing press, would enable central banks to strengthen their currency, he says. It also would create a significant new source of demand for gold—if, that is, it ever happens.
Gold is often viewed as a hedge against inflation, and it has outpaced rises in the cost of living—but not as robustly as the alternatives.
Since 1975, the beginning of the period in which private ownership of gold has again been legal in the U.S., the metal has returned an average of 0.8% annually after inflation, compared with 5% for bonds, 8.3% for stocks and even 1.1% for cash, according to Christophe Spaenjers, a finance professor at HEC Paris business school. “It can be very difficult to rationalize the price movements of gold, even with the benefit of considerable hindsight,” he says.
So, if buying gold is an act of faith, how much money should you put on the line?
Laurens Swinkels, a senior researcher at Norges Bank Investment Management in Oslo, reckons that the total market value of the world’s financial assets at the end of 2014 was about $102.7 trillion. The World Gold Council estimates that the world’s total quantity of gold held for investment was about $1.4 trillion as of late 2014. So, if you held the same proportion of gold as the world’s investors as a whole, you would allocate 1.3% of your investment portfolio to it.
Anything much above that is more than an act of faith; it is a leap in the dark. Not even gold’s glitter can change that.
— Write to Jason Zweig at intelligentinvestor@wsj.com, and follow him on Twitter at @jasonzweigwsj.
http://blogs.wsj.com/moneybeat/2015/...ts-a-pet-rock/
