Gold’s Rapid Rise! … Or Maybe Not

In May Peter Schiff, perennial bear and gold bug, doubled down on a prediction that now looks pretty ridiculous. The chief strategist of brokerage Euro Pacific and oft-quoted radio show host predicted gold would rise to $5,000 an ounce.

In case you don’t follow gold, it peaked in 2011 at $1,921 and has steadily declined since then, plummeting 43%. In May when gold was trading at $1,225, Schiff told MarketWatch that “there really is no limit to how high gold prices can rise.”

In his defense, with the eurozone wobbly and China’s stock market just having taken a major hit, he might have a point because gold is a great hedge against political and economic upheaval. At least, that’s what I would have argued in 2011, when gold was rocketing upward and we were still hung over from the 2008 financial crisis.

In a story for Kiplinger’s Personal Finance magazine, I argued then that investors should not succumb to gold fever for one reason: “When the developed economies get their acts together, that loud whooshing sound you’ll hear will be the fear being let out of gold prices.”

I bring that prediction up not to prove I was right but to offer a mea culpa, because I think I was wrong. If gold is such a great hedge against chaos, why hasn’t it strengthened in the last year? I’ll get to that in a minute.

But first I’d like to dispel other myths about owning gold. First, that it’s an inflation hedge. True, gold shot up during the high-inflation years of the 1970s, but that really hasn’t been correlated since, and only occasionally before. With historical hindsight, it appears the 1970s gold boom may have just been coincidence or a temporary belief that gold was indeed an inflation hedge.

Second, gold is a hedge against low interest rates. Well, interest rates have been rock bottom since gold peaked in 2011, and they haven’t stemmed gold’s decline.

Third, gold will protect us against profligate countries such as the United States, which keep printing money with abandon and flooding the world with currency and inflation. To quote something one of my daughter’s might say: “How has that worked out for ya?” This theory, though, just doesn’t hold water. Thanks to weak economies and weak demand, all that money continues to be sopped up and isn’t close to sparking inflation; in fact deflation worries continue to dog places such as the eurozone.

As powerful as this economic argument is, the lunatic fringe argument that runs in the shadows behind it rallies faithful gold bugs even more. Around 15 years ago I attended a gold conference where one speaker after another preached of the coming financial Armageddon in which only those who had accepted gold as their personal savior would survive.

Which brings me back to my mea culpa. Although I believed in the chaos-helps-gold-prices idea a few years ago, how do I explain the price of gold today? I now think that at different times for different reasons you can have chaos and dropping gold prices because of the nature of gold and the many factors that affect its price.

Right now a good sign of gold’s decline is the dollar’s strength. Gold is generally priced in dollars, but today’s strong dollar means you can buy less gold. Less demand means a lower price. The chart below shows the inverse relationship between the strength of the dollar and the price of gold.


So why are gold prices so fickle? No matter how much we love the stuff, why doesn’t it love us back as an investment?

Gold is a taker, not a giver. It doesn’t pay us dividends like stocks or interest like bonds. Unlike other commodities that are needed because we want to eat things (wheat), make things (copper) or build things (land), we don’t need gold except as a store of value—and it’s not a dependable one at that—because of its intrinsic worth and scarcity.

So why does gold even rise and fall? In a 2013 issue of the Financial Analysts Journal, a paper debunking the traditional reasons for owning gold came to the most reasonable explanation I’ve heard after years of trying to wrap my head around gold pricing. The authors said that gold has “positive price elasticity,” which means as gold prices rise people buy more of it because the price is rising.

That said, I own some gold, but not for any of the reasons above. I try to be agnostic when it comes to asset classes, and gold is truly in a class by itself. Because it doesn’t rise and fall with other investments—it’s what’s called a “non-correlated asset class”—gold dampens the volatility of my portfolio.

And to my mind the best vehicle for owning gold is the SPDR Gold Trust (NYSE: GLD), which we have in the Personal Finance funds portfolio. The fund not only holds physical gold but is also cheap to own and easy to understand: GLD shares track the price of a tenth of an ounce of gold.

For those true believers, who continue to have faith in gold as a hedge against financial Armageddon, I would suggest owning a reality check in the form of this gold Chicken Little charm, which you can buy on eBay: