July 31, 2012
If you were a time traveler, hopping from one point in history 2,000 years forward or back, you’d best carry with you – if your time machine will allow it – a small stash of gold. Gold has been an effective hedge against inflation over the very, very long term. But that’s about all it’s good for. The other common reasons for owning gold – in particular, to use as a short-term or even a long-term hedge against inflation – are baseless.
Those are among the findings in an interesting and informative article, The Golden Dilemma, by Claude B. Erb, a former investment management company executive, and Campbell R. Harvey, a professor of finance at Duke University. The two examined six arguments that have been advanced by advocates, such as the World Gold Council, for investing in gold.
One of them is that gold is an inflation hedge. On that score, Erb and Harvey uncovered intriguing anecdotal evidence that gold is a long-term inflation hedge. The evidence, however, applies solely to the very long term: 2000 years. For shorter periods – from a year to a lifetime – no support whatsoever exists for the argument that gold is an effective hedge against inflation. On the contrary, gold ownership poses a much greater financial risk than inflation itself.
In addition to the argument that gold is an inflation hedge, Erb and Harvey explored the validity of five other arguments for holding gold: it serves as a currency hedge; it is an attractive alternative to assets with low real returns; it is a safe haven in times of stress; one should hold gold because we are returning to a de facto world gold standard; and finally, gold is “under-owned.” In every case, the evidence advanced by Erb and Harvey strongly refutes the pro-gold argument. In fact, by the time Erb and Harvey are done, there remain only two possible investment reasons for direct ownership of gold: (1) as a risky “momentum” play; and (2) as a hedge against the remote risk of hyperinflation. I will return to these two justifications later.
A brief history of gold
For those fascinated by this particular precious metal, Erb and Harvey provide interesting information about gold supply and demand and gold markets. They report that the total quantity that has ever been mined, and hence the world stock of gold above ground, is an estimated 171,300 metric tons. That would form a cube 67 feet on a side. At today’s prices, all that gold is worth about $9 trillion (compared to about $90 trillion for the total value of global equity and fixed income).
Of the total tonnage, about 80% of it has been mined since 1900; hence, the legendary pillage of the Americas and the resulting gold and gold leaf adorning cathedrals worldwide represents only a small portion of the above-ground gold. Below ground, however, there is not very much left. According to US Geological Survey (USGS) estimates, there are 51,000 tons of recoverable gold remaining; but, like all USGS resource estimates, this represents the quantity estimated to be economically recoverable using existing technology and assuming current gold prices. That outlook could change with improved technology – perhaps the estimated 8 billion tons that reside beneath the world’s oceans, according to Erb and Harvey, could one day be recovered.
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