The Case Against Gold

Gold is usually cited as the ideal inflation hedge.  It has traditionally risen in value as inflation has ignited.  It is hailed a store of value.  Both of these attributes spring from what the gold bugs describe as gold's intrinsic value.

In classical economics, nothing has intrinsic value other than its observable price.  While this is definitive, I don't think that this is what gold bugs have in mind when they make their claim.  Rather, they are ascribing an inherent worth to gold which is independent of its market price.While it is an attractive assertion, I find it difficult to grasp.  Gold has little industrial use other than jewelry, so has very little continuing demand.  There is no income stream to be derived from ownership of the metal.  Finding intrinsic value in an asset that neither produces income nor is useful as a commercial input is problematic.

Gold's store of value property is easy to trace.  For much of the twentieth century, US currency was backed by gold, and for a shorter period was pegged to a fixed exchange rate.  Thus did gold hold its value over that period.  Even after the the peg was broken and the price of gold was allowed to float, its price relative to common items (a man's suit) and other commodities (a barrel of oil) remained fairly constant.  This was true during the inflation of the seventies and the long disinflation of the eighties and nineties.

These relationships have been broken.  Today, gold is trading at about $1400 per ounce, oil is at about $100 per barrel and a good quality man's suit can be had for about $600.  In the late seventies those numbers were $800, $40 and $250.  Where once an ounce of gold would once buy 20 barrels of oil, it will now purchase 14.  You could buy three suits with an ounce of golf and have enough left over for a shirt and tie; now you can get two suits and a couple pair of pants.

I believe that this loss of purchasing power is a function of the market's expectation of gold's role as an inflation hedge.  The markets have bid the price of gold up in anticipation of inflation which has not yet been experienced.  I would expect this to bode poorly for gold and an inflation hedge going forward.

What is an effective inflation hedge?  TIPS, though their prices have been bid up recently, the principal is absolutely indexed to inflation.  Income producing real estate, especially where leases allow for rents to increase with costs.  High yielding stocks of companies that will have pricing power to pass increased costs to customers.  And perhaps a bit of agricultural commodities or some proxy.