All That Glitters Is Gold
By Mark Lazar
There’s a lady who’s sure, all that glitters is gold. And she’s buying a stairway to Heaven. – Led Zeppelin
2019 has been a good year for owners of the shiny metal. Year to date, gold is up 17.53%, and is currently outperforming the S&P 500 by roughly one percent. But the past decade has been nothing short of a roller coaster ride, as the chart below illustrates; the 10-year average return for a gold ETF, has been just over 4%, whereas the S&P 500 delivered over 13% for the same period.
Let’s take a moment to better understand gold and what drives the price/value. A good place to start is its role in regard to our monetary system.
U.S. currency standard history:
1792–1834: predominately a silver standard
1834–1862: predominately a gold standard
1862–1879: fiat paper money
1879–1933: a true gold standard
1934–1973: a quasi-gold standard
1973–present: fiat currency only
Prior to WWI, international trade was based on a gold standard, meaning payments were settled with physical gold. This made perfect sense since there probably wasn’t much demand for Italian Lire in the U.S. in the 1800s, nor was there likely much interest in French francs in Tokyo during the same period.
Hence, gold was the preferred medium of exchange until 1944, when the Bretton Woods Agreement effectively passed the baton of international trade from the gold standard to the U.S. dollar, which was crowned the world reserve currency. However, gold was still the basis of currency values since the dollar was convertible to gold at a fixed rate of $35 per ounce.
The global financial system continued in this manner until 1971, when Richard Nixon officially ended the direct convertibility of U.S. dollars to gold. Since then the U.S. dollar and virtually every other currency on the planet has become a fiat currency. In other words, the greenback obtains its value not from gold or silver but, rather, our faith in it to serve as legal tender. If you look closely at a U.S. dollar bill you will notice it reads, This note is legal tender for all debts, public and private, which means U.S. dollars, by law, must be accepted for debts and commerce.
In addition to being a safe haven and long-term store of value for investors, gold is most a useful metal used in/for electronics 34%, jewelry 38%, official coins, and medals 22%, and dentistry & medicine 6%, to name a few. But despite the practical application of gold, investors flock to the yellow metal during times of fear and uncertainty. Besides the U.S. dollar & Treasury, gold is the “other” safe harbor investment. To make matters worse, approximately 50% of sovereign debt issued outside of the U.S. carries negative yields. To that point, on 8/16/19 the Swiss 10-year bond was issued with a negative 1.09% yield, meaning an investment of ₣100,000 Swiss francs today would be worth less than ₣90,000 Swiss francs in ten years. Gah! It’s not surprising then that foreign investors are looking across the pond at greenbacks as well as gold, both of which appear relatively attractive compared to a negative yield bond.
Gold is oftentimes considered an inflation hedge. We disagree as there is plenty of evidence to the contrary. However, evidence does suggest that gold tends to move counter to lose or expansionary monetary policy, which oftentimes does lead to inflation, but not always. This makes sense since tight monetary policy (shrinking the money supply, or M2) makes the dollar more valuable. Conversely, loose monetary policy (expanding the money supply) does the very opposite.
We don’t have a crystal ball, but sure wish we did. However, if central bankers continue to practice monetary chicanery (i.e. reckless currency devaluation), gold will likely continue to move higher.
Mark Lazar, MBA
Certified Financial Planner®