After the Gold Rush

Falling Prices Typically Correspond with an Improving Economy

The gold rush, at least for the time being, is over.

“Not to put too strong a spin on it, but in our view, gold in most times is seen as an alternative, something you go to almost by default. For example, gold often does well when there’s a lot of fear in the market,” said Tim Suffish, senior vice president of equity markets for St. Germain Investment Management in Springfield.

“In, quote-unquote, ‘normal’ times, you invest in stocks, invest in bonds. You’re looking for growth, and bonds tend to perform well in that environment. When you’re scared of something — inflation, or the Eurozone is going to blow up, or geopolitical saber rattling — any time there’s fear in the market, gold will tend to perk up as an asset.”

With the economy — and especially the stock market — humming along compared to the dark days after the financial collapse of 2008, that squeezes out gold, a reality reflected in its falling value. At its recent peak, late in 2011, gold was selling for almost $1,900 per ounce, but has hovered around $1,200 in recent weeks, as the economy adds jobs and the Federal Reserve expected to begin increasing short-term interest rates, which could soften the demand for non-interest-bearing assets like gold.

That softening was clear through last year, as gold-coin sales by the U.S. Mint declined by 36% from 2013. Simply put, an improviong economy is bad for gold.

“People are always asking me, ‘is gold a good investment?’ My answer is always the same: ‘it had better not be,’” wrote Louis Woodhill, an economist who writes a column for Forbes.

“Periods in which investors could profit by buying and holding gold have been terrible for workers and for the economy as a whole,” he noted, adding that buying gold is less of an investment than a trade, a zero-sum game where whatever one ‘investor’ gains, another loses. “From the point of view of the real economy, gold is not an investment at all. Real investment makes everyone better off. Trades produce winners and losers.”

As a firm that deals in long-term investments, Suffish told BusinessWest, “gold is something we don’t really invest in. For the most part, it’s something we don’t really believe in.”

That’s not to say it’s inherently bad. “It’s seen as alternative currency. When there’s not a lot of trust in the U.S. dollar or mainstream currencies, gold is seen as the ultimate alternative currency. That’s a good thing; you can’t print more gold, just like they’re not making any more Florida real estate.”

But in a strengthening economy, he added, investors should look elsewhere.

Long-term Loser

Economist Brian Lund, in a column for dailyfinance.com, cites research by economics professor Jeremy Siegel that tracks the long-term performance of various asset classes in terms of purchasing power, adjusted for inflation. Basically, he determines what a $1 investment in 1802 would have been worth in 2006.

Stocks far outpaced the other vehicles, returning $755,163. Bonds and T-bills returned $1,803 and $301, respectively, on the initial dollar investment. Gold didn’t even double in value, coming in at $1.95.

True, this doesn’t reflect the recent peak in 2011, but the underlying point is that gold is a poor long-term investment.

“In addition to its miserable historical performance,” Lund added, “gold also has many other failings as an investment, not least of which are the cumbersome and inefficient options available to own it.”

For example, he said, shipping costs of buying gold in bullion form cuts into profits, and so does storing it. “Keeping it at home exposes it to the risk of theft, fire, or natural disaster. Taking it to the bank requires the rental of a safe deposit box, the cost of which will eat into your profit as well. Firms will store your physical gold on site, but they charge for the service, and the idea of having your yellow treasure held by someone somewhere else, commingled with that of others, is not very appealing.”

Suffish agreed. “If you can invest in a nice, blue-chip U.S. company, like Johnson & Johnson or Procter & Gamble, that pays good dividends, they literally pay you as a shareholder,” he said. “When you invest in gold, you have to pay to own it — to insure it, to store it. Similar to real estate, it has costs associated with it.”

Still, he added, “when there’s strong inflation, gold should do well.” Unfortunately for gold investors, that’s not the case right now.

“The good news is that there is no inflation,” economist and journalist Larry Kudlow noted late last year. “That’s largely because those excess reserves at the Fed have not circulated through the economy.”

But mostly, Suffish said, it’s a lack of fear in the economy — which most would consider a good thing — driving the downward momentum of gold.

“When looking for alternatives in the portfolio, gold sometimes gets a small piece of the pie. But gold has not done well for the past couple of years; it’s down a third from its peak in 2011,” he noted. “At the same time, the measures of fear in the market have come way down, the measures of inflation have come way down, and especially in the past six months, the dollar has done very, very well.

“Our economy, even though it’s not hitting on all cylinders, is better than alternative economies out there right now,” Suffish went on. “We have an environment of low fear, low inflation, and a strong dollar — and the combination of those three is very bad for gold historically.”

Finance journalist Marcie Geffner made a similar observation at bankrate.com.

“Gold’s rise in the past has been driven by fear of the unknown and the unthinkable,” she wrote recently. “The unknown was whether the U.S. dollar would weaken. The unthinkable was whether the world’s major economies would suffer another near-catastrophic financial crisis.”

Hedging Their Bets

Still, the meteoric rise of gold prices in the late 2000s made it attractive as a short-term investment, or at least a hedge, she noted, but not much else. “Gold might be a glittering temptation for investors looking to fatten their investment returns with a relatively safe commodity. But it’s far from foolproof.”

Suffish noted that, before its recent rise, “it was dead money for a long time, but that was really true of all commodities; they were dormant from the ’80s through the early 2000s. Then commodities really perked up.”

That had to do with the rise of exchange-traded funds, or ETFs, in the 1990s. “Through ETFs, you could invest in gold, oil, and natural gas, and a lot of commodities had a good run for a period of years during that time,” Suffish said. “In the 2000s, gold went from well under $100 all the way to $1,800. Over that time, it gave you some good returns. But in general, [commodities] have not been great long-term growers in portfolios.”

As for the near future of gold, “there are lots of analysts that are trying to forecast where gold prices will go next,” Woodhill wrote. “This kind of prediction is fundamentally impossible, because future gold-price movements will be caused by events that have not yet happened.”

But if their direction continues to reflect the opposite of the economy in general, falling gold prices might not be such a bad thing.

Joseph Bednar can be reached at [email protected]