is gold a good investment
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12/23/2015 Is Gold a Good Investment?
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10 / 27Is Gold a Good Investment?
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As a general rule, gold is not a good investment.
It doesn't earn income. And because it doesn't earnincome, it doesn't benefit from the law ofcompounding returns ‐‐ what Albert Einstein oncecalled the "eighth wonder of the world."
The magic of compounding returns
Returns that compound are an investor's biggest ally.They transform ordinary gains into spectacular ones.
Let's assume, for instance, that Jack spends $100 tobuy one share of Rob Harrison, a fictional company that earns and distributes $10 per sharea year selling banana smoothies.
If Jack uses the $10 annual dividend to buy accessories for his 1994 Ford Explorer ‐‐ asopposed to reinvesting the money and allowing it to compound ‐‐ he'll earn $300 over 30
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12/23/2015 Is Gold a Good Investment?
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years.
That equates to a 300% return.
This isn't horrible, but it pales in comparison to the 1,654% return earned by Jack's brother,Henry, who reinvests the annual dividends into additional shares of Rob Harrison,
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Chart by author.
By harnessing past earnings to generate future earnings, Henry has engaged the power ofcompounding, which increases the size of his return each year.
After three decades, Henry will own 17.5 shares that generate $175 in annual dividends. Bycontrast, his brother, Jack, will still own only one share earning the same $10 a year.
The problem with gold, in turn, is that it doesn't allow investors to benefit from this magic.
As a nonproductive asset ‐‐ one that doesn't produce income ‐‐ even a prudent and patientinvestor like Henry can't use it to tap into the law of compounding returns.
SEE SLIDESHOW: 25 Amazing Facts About Gold
12/23/2015 Is Gold a Good Investment?
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1. The world's largest known gold nugget was found near Moliagul in Central Victoria, Australia in 1869 ﴾weighing 2316 troyounces﴿. It was called the 'Welcome Stranger.'
﴾Source: World Gold Council﴿
The siren song of gold
To be fair, there are times when gold outperforms income‐generating assets such as stocksand bonds.
In the late 1970s, rapid inflation increased the demand for gold, which is believed to be aneffective store of value. This fueled a rise in gold prices from $400 an ounce in 1976 up to$1,500 an ounce four years later.
The same thing happened during the financial crisis of 2008‐09, during which investors fledstocks in favor of gold and other, presumably safer types of investments. The addeddemand caused the price of gold to increase from less than $400 an ounce in 2000 to morethan $1,600 an ounce 10 years later.
1/25 SLIDES © Bloomberg
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Data source: Federal Reserve Bank of St. Louis. Chart by author.
But the problem in both of these cases is that the price of gold soon dropped as quickly asit had formerly climbed.
It was less than $600 an ounce by 1985. And since peaking in 2011, gold has lost more thana third of its value.
To benefit from these fluctuations, then, an investor would have to time the market ‐‐something we know to be dangerous, if not impossible, for the average investor to dosuccessfully.
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