Paper vs Gold

Last month I explained why gold is not an asset to hold in every kind of market. But here’s an even more extreme piece of evidence.

During the last 200 years — an era of unprecedented growth and development — paper investments have trounced gold:

Now there are two perspectives on this:

  1. Gold is so far behind because it has no inherent value, it creates no product or new income, or innovation. It just sits.
  2. Gold is so far behind because stocks, bonds and dollars in a humungous, history-shattering bubble.

We shall see which case is correct.

Investors need to remember that the reasons for gold’s present strength — above all else mismanagement of the global economy and international financial system by governments and large financial corporations which has resulted in a low-growth, high unemployment, negative real rate environment — although historically abnormal, will eventually subside, and we will return to the historical norm where gold significantly under-performs paper. That’s because gold just sits, whereas other assets either produce a net return, or are a net liability.

As I explained last month:

I believe that in order to restore growth, what the system needs, and what it is driving toward is restructuring. This can either be accomplished intentionally through explicit haircuts or defaults, through high inflation, through a slow painful private deleveraging process or through strong organic growth.

I don’t know how debt reduction will take place. It could be three months or years away, or it could be another grinding, unemployed and depressed ten years, full of false dawns. Certainly that is what has happened to Japan since its stock market and real estate bubbles burst twenty years ago. Maybe the West will perform better than Japan in the deleveraging trap — maybe new technological innovations like cheap decentralised solar energy will provide the necessary organic growth to overcome the debt problem. Or maybe not.

Until the private debt load is significantly reduced, it will act as a huge weight tying down economic growth, tying down employment, and structurally weakening both the financial system and society. High debt loads require low interest rates to sustain — which with a little inflation means negative real interest rates. Gold has traditionally done very well in low real rate environments.

Once the deleveraging trap has been left behind, it will be the time to ditch gold and plough all of that purchasing power into productive assets: industrial stocks, real estate, farm land, inventory, and labour force.

And gold will once again settle into significantly under-performing stocks.

11 thoughts on “Paper vs Gold

  1. I’ve seen this 200 year return statistic before, though it is usually stated in some manner of % gain per year. What you have touched on that many don’t is that Gold is not meant as a long term investment vehicle but as a transporter of value through times of instability. So what is missing in all these analyses of 200 years of gold ‘returns’ is that nobody lives for 200 years. As JMK said correctly: in the long run, we are all dead (or as Tyler Durden said: on a long enough timeline, the survival rate for everyone drops to zero).
    So 200 year returns are meaningless. We live around 70 years, invest for 20-40 of those. So all investments should be evaluated in their performance for that time period – and that captures different start/stop times for each individual. If you are 30-40 years old, how have stocks fared during your time of investing? That’s the key. Not what they were doing in the 1800’s.
    Still, your conclusion is correct and someday soon we’ll be buying blue chips for bargain prices with the value currently stored in a yellow metal.

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  4. I don’t have time to dig up numbers and look into this now (might do so later today if I get round to it) but I don’t think these numbers are correct. $10,000 invested in gold in 2008 would yield $26,000 today. An ounce of gold 200 years ago cost around $20, today it’s around $1800. That’s about a 90-fold increase. Multiply that by $10,000 and you get $900,000 return for gold.

    Also, I suspect the numbers for bonds and stocks are calculated using the utterly meaningless measure called the CPI. This is useful for making multiple choice questions for my undergrads, and useful for mainstream keynesian charlatans to pontificate about how expansionary monetary policy isn’t causing any price rises in spite of the rising price of everything that people buy. But it is an utterly meaningless measure for those of us who live in the real world. The only real measure of dollar value destruction is the price of gold. Once you think of it that way, I think the numbers would look different.

    • Indeed — I have given a pretty extreme example from the paperbug side of the argument.

      Here’s a more balanced picture of the relationship between stocks and gold:

      The comparison really becomes clear when we introduce a fourth asset-class: cash.

      While stocks and bonds have gained a lot of purchasing power (but debatably less than the official figures), and gold has gained some purchasing power, cash has lost a lot of purchasing power:

      The key is that while stocks and bonds have historically gained more purchasing power than gold, there are some periods in history (usually ones of turmoil, bad government, etc) where gold massively outperforms them (I refer to these as “gold denominated deflation”, i.e. the periods in the first graph where the cost of the DJIA in grams of gold massively drops). This has happened twice in the floating currency era:

      Ultimately, gold is the ultimate store of value and purchasing power. The point of this post is to impart to readers what I believe the financial elites have long understood — the global economy naturally goes through cycles (debatably called Kondratieff waves of 15-30 year technological evolution). During periods of calm and growth gold should be bought cheaply and stored. At the end of the cycle, when the world is panicking (due usually to war and defaults) and gold is at its highest (we are nowhere near there yet — my prediction for this cycle is that the DJIA:AU ratio will go to 1:1 o/z) gold should be sold and converted into productive assets, and so the cycle begins again.

      Many elites have practised this since the days of Napoleon, and perhaps earlier (Venice).

    • Exactly… I was just about to say the same..
      26000 gimme a break…
      Btw… could have bought a stock that would have been here still for 200y …. NOPE. So the profit of stocks goes immediately to ZERO

  5. Point me to a BOND and/or STOCK which have been available for the last 200y.
    AND then tell me what is its price then and now.. then we can compare.

    • Well the point is that the bonds are rolled, and the “stocks” are actually indexes. But yes the figure for gold is very much a low-ball figure, and stocks and bonds are high-ball figures. But that doesn’t defeat the point I am trying to get across which is that if you want to maximise purchasing power there will come a time (probably when DJIA:AU hits 1:1) to cash out of gold and cash into blue chips and real estate. Because the truth is that gold only really performs in times of crisis and huge money printing.

  6. I have been meaning to write a follow-up to this forever. This is an invalid comparison, as it is similar to looking at average height gain in America over the last 200 years and concluding that a person born 200 years ago would be today equal to the sum of all that height gain. It misses the fact that people die and new ones are born, their height gain does not add up.

    This comparison looks at stock and bond indices and averages, and in doing so, removes the real effect of losses and bankruptcies. In each of these 200 years, a lot of people were wiped out, one way or the other. These people’s returns reflected on the average returns of that year, but they did not have any money to invest in the next year. Here we can see the problem with this 200-year average nonsense. If you invested in stocks, there were many years in which you might have been wiped out, meaning that the average returns made in the next year mean nothing to you. Holding gold, on the other hand, does not have this risk.

    A far better comparison would be to look at real life portfolios of real-life people over long periods of time and see what the reality of their performance was compared to gold.

    • This is a valid point.

      Nonetheless, I still feel that the best investment strategy is (more or less) to hold mostly equities and productive assets that produce a return during periods of organic growth and expanding productivity (i.e. gold-dominated periods of inflation) and mostly gold and commodities during periods when the markets are bleeding (i.e. gold-denominated periods of deflation).

      The problem is that right now we are in a massive trough of gold-denominated deflation, and I not see much light at the end of the tunnel.

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