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The Real Story of Precious Metals' Returns

by: Hard Assets Investor August 25, 2008 | about stocks: GLD / SLV

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By Brad Zigler

Old guys like me can recall Certs ads featuring two people earnestly arguing over the mints' proper taxonomy. To each exhortation made by one ("It's a breath mint!") came the rebuttal, "It's a candy mint!" Universal harmony is ultimately restored through the intervention of an announcer declaring Certs to be "Two ... two ... two mints in one!"

Exchanges between hard money advocates can sometimes take on the characteristics of those old commercials. The retort, "Gold is catastrophe insurance!" is often uttered in response to the claim, "Gold's an inflation hedge!"

If recent history is any guide, gold's more of one than the other. There's yet a third role for the yellow metal, but let's not get ahead of ourselves.

A little history first ...

Gold's had a quite a ride since President Nixon ended the fixing of gold at $35 per ounce. Once unfettered, gold was quickly propelled higher, taking silver along for the ride. At the apex of an inflationary cycle in 1980, gold's price (the red line in the chart below) averaged $615 an ounce, while silver's (black line) middling sales price was $21 an ounce. Over the course of the first decade shown on the chart, gold's price appreciated 1,600%; silver's 1,100%. In that same 10 years, stocks, as measured by the Standard & Poor's 500 Index (blue line), managed a rather anemic 42% gain.

Average Yearly Prices (1970 through July 2008)

After 1980, fortunes reversed, sending precious metals prices into a two-decade swoon. It took gold until 2007 to finally surpass its 1980 average price. Silver, however, lagged and still hasn't matched its old record. Stocks, meantime, gained 1,500%.

All fine and good, you may say. People who bought gold back in 1980 finally reached breakeven in 2007.

But did they really?

After all, gold doesn't earn interest, and it costs money to store, insure and transfer the metal as well. If that weren't bad enough, there's that pesky inflation problem. Adjust asset prices for changes in the Consumer Price Index (CPI) and you get a chart that looks quite different.

Despite gold's brief foray above the $1,000-per-ounce level this year, 1980 gold buyers are still far from breaking even. To reach purchasing power parity, in fact, gold's 2008 price would have to average $1,641 per ounce. Folks who bought silver in 1980 will be behind the eight ball until the white metal's price averages $52.

CPI-Adjusted Average Prices (1970 through July 2008)

From this, it would be easy to say that gold's not the inflation hedge it's touted to be. But that's not really the case. In fact, gold provided a 4%-per-annum real rate of return since 1970, topping the inflation-adjusted returns of stocks and silver.

Asset Performance (1970 Through July 2008)

	Average Annual Return (Nominal)	Average Annual Return (CPI-Adjusted)	Reward-to- Risk Ratio
Gold	8.7%	4.0%	0.32
S&P 500 Stocks	7.5%	2.8%	0.58
Silver	6.1%	1.7%	0.19

If gold, or any of the other assets for that matter, hadn't at least kept pace with inflation, its real return would be negative.

Still, you shouldn't be lulled into thinking that holding gold earns you 4% over the inflation rate each and every year. That's the average return over a nearly four-decade-long hold. Pick a different starting point and you can end up with a vastly dissimilar return.

Just ask those people who bought gold in 1980, and look at the market through this lens:

Asset Performance (1980 Through July 2008)

	Average Annual Return (Nominal)	Average Annual Return (CPI-Adjusted)	Reward-to- Risk Ratio
Gold	2.3%	-2.1%	0.09
S&P 500 Stocks	9.0%	5.3%	0.69
Silver	-0.7%	-4.0%	-0.03

Buying at a speculative top clearly hurt these folks. Stocks were notably kinder to this generation and to the next cadre of investors that followed a decade later as well:

Asset Performance (1990 Through July 2008)

	Average Annual Return (Nominal)	Average Annual Return (CPI-Adjusted)	Reward-to- Risk Ratio
Gold	4.8%	1.9%	0.35
S&P 500 Stocks	8.0%	5.0%	0.61
Silver	7.1%	4.1%	0.39

The most recent cohort of investors' affinity for precious metals can be readily understood when we compare the asset returns generated over the past eight years:

Asset Performance (2000 Through July 2008)

	Average Annual Return (Nominal)	Average Annual Return (CPI-Adjusted)	Reward-to- Risk Ratio
Gold	14.7%	11.5%	1.22
S&P 500 Stocks	-0.2%	-3.0%	-0.01
Silver	15.7%	12.4%	0.72

For all but the nearest investment horizon, the drawdown risk for gold and silver investments is significantly higher than that associated with stocks. The volatility of the markets is reflected in the reward-to-risk ratios. Until very recently, stocks were a more reliable source of returns.

If there's one thing that should stand out from the charts and tables, though, it's the countercyclicality of precious metals and stocks. Note how the precious metals spike of the 1970s coincided with a slump in the stock market. Later, in the ‘90s, metals buckled while stocks soared. With the advent of the new millennium came another cycle favoring metals.

The integration of these noncorrelated assets into a portfolio can actually reduce overall volatility. Dampening volatility, in turn, reduces drawdowns, allowing investors to keep more of their gains. Here, the greater variance in metals prices can be a boon: The higher the volatility, the smaller the allocation required to obtain a diversification effect.

So, what can we take away from all this? Simply this: Gold can provide a return above inflation, though that return is highly volatile. That volatility, however, means a portfolio requires only a modest exposure to metals to obtain diversification.

And that, to paraphrase yet another old commercial, allows you to "double your pleasure; double your fun."

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Jack Lifton: The Technology Metals Age Jan 07, 2009
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This article has 20 comments:

Aug 25 12:33 PM
Don't use the official CPI you know that it's "adjusted" and tweaked all over the place. Use the real inflation figures from shadowstats.com or other real tracker of price inflation. You'll see gold outperforms substantially in generally and is fairly noncorrelated as well.
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Aug 25 12:50 PM
By definition, gold's after-inflation return is 0.0% in the long run. There is plentiful literature to support this view - which is that gold buys approximately the same amount of food and clothing in the long run. Long run means roughly a few centuries that are covered in Adam Smith's book, plus as far as i understabd ancient rome had approximately the same prices for foodstuffs as they are now.

So, if you include the cost of capital, holding gold is an investment that sets you back in the long run. The only reason that you got this +4% return is that the price was artificially low for quite some time when Nixon freed it.
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Aug 25 12:50 PM
By definition, gold's after-inflation return is 0.0% in the long run. There is plentiful literature to support this view - which is that gold buys approximately the same amount of food and clothing in the long run. Long run means roughly a few centuries that are covered in Adam Smith's book, plus as far as i understabd ancient rome had approximately the same prices for foodstuffs as they are now.

So, if you include the cost of capital, holding gold is an investment that sets you back in the long run. The only reason that you got this +4% return is that the price was artificially low for quite some time when Nixon freed it.
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Aug 25 12:55 PM
"the nearest horizon" is the most relevant, is it not? Doesn't the enormous difference in recent performance jump out at you? The 49ers and Bengals played a couple of great super Bowls in the early 1980's, but I dont expect to see them there this year.
Even by Brad Ziglar's logic, if you expect a slump in the stock market, buy metals.
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Aug 25 12:58 PM
The conclusion I would draw from this article would be summed up by the following lifetime investment strategy:

1) Hold multiple asset classes (equities, commodities, bonds, real estate, cash)

2) Sell most of an asset class after a period of 8-10 years of overperformance, locking in your gains.

3) Use the proceeds to buy more of whatever performed poorly during the current decade / cycle. History shows that class will outperform during the next decade / cycle.

4) 8-10 years later, reinvest in the asset class you sold earlier, once it's historically cheap again. All things revert to the mean!

To sum things up: rebalance your portfolio and invest like a contrarian!

To do that, you can't get emotionally attached to any investment class, or ever assume that something will always go up. You have to sell the asset classes that have rewarded you in the past and buy things that everyone agrees are stinkers. To do this is to defy your human nature.

Applied to today, commodities/metals/ene... and real estate have just completed most of a decade-long run, mostly at the expense of equities (which were a great investment in the early 90's, at the expense of hard assets). The trend could continue for a couple more years or we might have already turned the corner - only bloggers think they know for sure!

Just be aware of the changing trends, and spend the next 2 years getting into position for the next decade (2010-2020) when equities will again take over. Just don't get too attached...
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Aug 25 12:59 PM
sorry but you don't get it. Gold is not an inflation hedge - if you define inflation as cpi-increase. price rises are NOT equal to inflation. inflation is a monetary phenomenon and its effects are often (not always) rising prices. And often such price rises can be postponed far into the future. In fact, it can be argued that gold will NOT protect you against the 'normal' everyday inflation but against once ina lifetime (or once in two generations?) events of rapid paper currency devaluation or outright currency failure. These events always occur when all other means by governments and central banks have been exhausted and a radical expropriation of currency and government bondholders is the only option left. This point cannot be accurately predicted by any means - much like a hurricane kathrina event. the only thing you can observe that at some point it will inevitably occur - but that could be next year, next decade or 100 years from now. But occur it will, and in the case of fiat currency, the damage will grow exponentially over time.
Gold is an insurance against that - not more, not less. therefore, it should be treated as an insurance - not as an investment. 5-10% of the portfolio in physical gold is fine. physiacal- not paper gold. Buying paper gold is like insuring against a hurricane with a policy from an already bankrupt insurer. you can feel safe but will get nothing when crisis hits.
people wjho bet 50% or more of their money on gold's rise are nuts and gamblers, imho, even though of course you could make a case that with every year passing, the BIG payoff day draws nearer. Still, i would not want to hold a portfolio containing to 50% an insurance contract (gold) that might reward me only 20, or 40 years from now.
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Aug 25 02:02 PM
Um, your SP500 since 1970 figures are for the index number itself, which does not include the dividends. The total return of the SP500 trounces gold in any truly long term view.
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Aug 25 02:18 PM
Jason--You are right. Gold is for trading--never hold long term. Gold like real estate (very similar to gold) only go up for inflation. Stocks beat both of them big time.
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Aug 25 04:53 PM
FX Trader,

The author did not suggest buying a specific percent of gold. Naturally a huge chuck of a portfolio would be inappropriate for the long term. He is showing how the negative correlation to stocks makes it a good portfolio diversifier.

I don't see how making a distinction between Inflation (increasing money supply) and Prices would change an investor's decision on whether to buy gold and if so, how much to buy. We all understand that we are investing to increase/maintain our purchasing power.

But I do have a question for you. Do you have any data (preferably a chart) showing inflation of the USD? I'd love to compare a CPI chart to an inflation chart.

But what really matters here
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Aug 25 05:02 PM
Chris B,

I like your long-term investment approach. However, your 8-10 time frame appears to be arbitrary. If not, can you tell me hwy you chose it?

Jim Rogers says commodity cycles run about 18 years on average (his range was surprisingly narrow: 16 years was the shortest and I don't remember the longest but think it was about 22 years). If he is right (I would not bet against his long-term calls) then we are approaching the mid point. However, he thinks this one will be longer than usual and possibly the longest ever because the the size (population) of China & India.

You may want to hang on to your commodities for longer than you otherwise would have.

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Aug 25 07:15 PM
Insurance usually expires worthless, unless the insured event comes to pass. (or whole life insurance).

Gold doesn't expire worthless. Its also a store of value. I'm not buying insurance on when I buy gold because it doesn't go to zero if inflation moderates. it might under perform for a decade or two.

The authors main point is an excellent one--that different asset classes have periods of out performance, followed by underperfomance.

Certainly a decade or more of gold out performance doesn't mean that gold is "only for trading", but rather should be part of a diversified portfolio, along with oil and DBA, and other commodities.
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Aug 26 12:14 AM
Whether I'm going to own a stock depends on my evaluation of the company's fundamentals and in some cases the stock's technicals. It has nothing to do with the "return" I would receive on gold, which is nothing. In other words, one needs to evaluate the risk/reward of a particular stock against the baseline offered by gold (no risk, no reward). Gold is money. It is what you own when the risk/reward on investments is unfavourable. Its returns relative to other assets may appear positive or negative, but in absolute terms they will always net out to zero. Therefore it should not be compared with stocks as if it were itself an investment. In short, gold is not an investment, it is the absence of investment.

As for gold's price in US dollars, that says a lot less about gold or stocks than it does about the US dollar. The dollar should itself be evaluated like any other paper asset: what does it yield, what does its balance sheet look like, and what is the supply and demand picture? If the dollar has favourable fundamentals and/or technicals, it may be worthwhile as a trade or an investment. But it is not a reliable store of value, and for that reason nor is it a benchmark against which long-term investments, such as stocks or long-dated paper, can be evaluated meaningfully.

If you want to write an article about stocks that also mentions gold in a useful way, you would start with charts of the S&P 500, priced in gold. Bonus points for measuring the total return on stocks - dividends matter, a lot.
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Aug 26 12:25 AM
Let’s see, in 1868 a silver dollar would buy you a bath, a nice steak dinner, and a night’s stay in a luxury hotel.

Today an ounce of silver won’t even buy you much of a meal. Sounds like a lousy inflation hedge to me.
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Aug 26 03:19 AM
Gold, Oil, Corn, Dollar, Euro, Yuan, Stocks, Bonds, etc, etc, etc ad nauseam - all floating up and down against each other by the minute, the day, month, year, decade, century, etc.

All have been presented at some time or other, in various combinations and ratios over various time-periods to make some behavioral point and/or to portend the future.

To a non-economist, it's all very confusing . . . . is there really not any single asset in this world that can be considered absolutely constant in it's value to mankind, against which all other assets can be meaningfully compared?

(when I was younger, it was claimed that the Mars bar was such an asset, but my question above is a little more serious).

T.C.
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Aug 26 09:11 AM
Just like to add something simple. EVERY asset will yield a profit if bought at it or near its 52 week low.the trick is knowing where that is.
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Aug 26 09:51 AM
In 1868 a silver dollar did not weigh a troy oz,nor was Wall Street equiped with all sorts of electonic black boxes to crap on anyone in the way when they are knee deep in worthless paper,so they attact the Silver & Gold markets! Now if you had that exact 1868 Silver Dollar in new like condition,you could buy a lot more than all you said,that coin could bring in the Millions to the right person!
That just shows you,the Worlds money was taken over long ago,if you are a part of that bunch born to that family,you carried on the same creepy crimes as of your elders,lies,cheat & control the money supply!But sooner or later,a fight breaks out in families of where such Greed is breed into them from the cratel!
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Aug 26 10:44 AM
Good commentary.

@webisking - that rule of thumb only works in a bull market. If the trend is a bear market, then it's quite likely that something that is at a 52 week low today, will be at a lower 52 week low in a few weeks or months. Bottom feeding is pretty dangerous!
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Aug 26 03:53 PM
35 years is a long time for comparisons. Show me an investor who has kept any investment (perhaps a good paying rental property) for 35 years!!

A 15 year time frame is appropriate.

Obviously, gold and silver are not always going to outperform. No asset type can 'always' out perform. If you want to outperform you MUST do some sort of trading - probably infrequently.

Also, gold and silver are really 'money' not investments. Their only competitors are physical cash in terms of bank notes. How many of these to you keep stashed away? Most people have some, but not too much. If you are going to keep money for a rainy day, then it should not be all banknotes. Neither gold nor banknotes pay interest, but Gold is much safer.

For those who like to compare back 100 or 200 years. Show me a basket of stocks which existed back then that are still around and never went bankrupt during the period. Very, very few survived. The chance of your ancestor picking one is extremely remote.
However, if they picked gold, it would still be worth something.

The chance of a major company that exists today or even the US dollar for that matter surviving for another 100 or 200 years is remote. However, gold will still be worth something in 500 years.

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Aug 27 11:53 AM
"A good man leaves an inheritance to his childrens children"

Gold retains its buying power over time.

I dont buy gold as an investment, its a storehouse of value, period.

www.rapidtrends.com/bl.../
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Aug 28 04:18 PM
enviro111 - you roll from company to company of course - that is what the indexes are, and the total return from investing in them was and is available to anyone, at all times. It isn't survivorship bias at all.

As for the question one poster asked, isn't there some asset whose value never changes, the answer is no, of course not. The value of everything depends on the entire constellation of demand, and on the aggregate wealth of all other men, their techniques and skills, their laws and their decency or lack thereof. To those who think gold always retains its value, as how much it helps a peasant herded into a collective farm in a communist country, or someone in a major city being firebombed.

It used to be known to every investor that "do what you will, capital is at hazard". There simply is no such thing as safety in any absolute sense. On a sufficiently long time scale, everything is subject to the gales of history. That is why you are not surrounded by patient billionaires whose fortunes stem from their family endlessly rolling over the compound interest on 30 pieces of silver since Roman times. Look around. The present rich are, instead, recently successful entrepeneurs for the most part, with a thin smattering of older wealth only in a few places in the developed west, that have enjoyed the best security and legality in recent times.

You can't navigate history by abstracting from it or wishing it would go away. Bottom line.
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