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Gold bugs – those individuals that own gold for fear of inflation, currency value decline or Armageddon – should check historical relationships to this belief, suggests Campbell R. Harvey. Harvey is a J. Paul Sticht Professor in International Business Fuqua School of Business, Duke University, and author of “The Truth about Gold: Why It Should (or Should Not) Be Part of Your Asset Allocation Strategy,” (CFA Institute Conference Proceedings Quarterly, March 2013).
Harvey’s analysis concludes that gold does not provide a hedge for inflation, “surprise” inflation or act as a currency hedge. Yet, there is some indication that it does support hyperinflation.
While Harvey concludes little reason to hold gold, he does site two arguments in favor of gold. First, developing markets could increase the demand for gold, causing an increase in the price. Second, if all investors held gold in terms of its percentage of net worth in the world, price would increase with increased demand.
Here’s a look out how gold plays out in less favorable ways:
- Gold as a hyperinflation investment – Beginning in 1980, Brazil saw inflation jump 250% in 20 years, but due to the increase in stock prices elsewhere, gold performed poorly, dropping nearly 70%. When Germany saw hyperinflation from 1920 to 1924, gold held its value rather than increase in value.
- Gold as a safe haven – Comparing the performance of gold, short-term bonds and stock prices (S&P 500) from 1975 until 2012, gold and stocks fell in tandem 17% of the time while short-term bonds and stocks fell in tandem 0% of the time. Short-term bonds would consequently be the better investment if investors sought a safe haven.
- Currency hedge – When prices of currencies decline, gold should increase in value. However, Harvey found that for every 10% decline in the value of currency, gold only increased 0.10% to 2.4%, which is not enough to offset the decline in currency value.
- Price of gold to inflation – Since 1985, the price of gold relative to inflation has been about 3.2 times. Although this price has changed considerably from one year to the next, ranging from 1.5 to 8.5 times, the price returns to the average quite quickly; however, the lack of consistency from year-to-year makes gold a poor investment.
The best conclusion is to invest as gold prices begin to increase in value and sell when prices decline. In other words, apply a momentum-based approach to investing in gold.