Is Gold a Good Hedge?
Martin Feldstein
CAMBRIDGE – As I walked through the airport in Dubai recently, I was struck by the large number of travelers who were buying gold coins. They were not reacting to Dubai’s financial trouble, but rather were joining the eager rush to own gold before its price rises even further. Such behavior has pushed the price of gold from $400 an ounce in 2005 to more than $1100 an ounce in December 2009.
Individual buying of gold goes far beyond the airport shops and other places where gold coins are sold. In addition to buying coins minted by several governments, individuals are buying kilogram gold bars, exchange-traded funds that represent claims on physical gold, gold futures, and shares in gold-mining companies that provide a leveraged position on the future price of gold.
And gold buyers include not just individuals, but also sophisticated institutions and sovereign wealth funds. Recently, the government of India purchased 200 tons of gold from the International Monetary Fund.
Many gold buyers want a hedge against the risk of inflation or possible declines in the value of the dollar or other currencies. Both are serious potential risks that are worthy of precautionary hedges. Although inflation is now low in the United States, Europe, and Japan, households and institutional investors have reason to worry that the low interest rates and the extensive creation of bank reserves could lead to inflation when economic recovery takes hold. And the declining value of the dollar – down more than 10% against the euro in the past 12 months – is a legitimate cause of concern for non-US investors who now hold dollars.
But is gold a good hedge against these two risks? Will gold maintain its purchasing power value if inflation erodes the purchasing power of the dollar or the euro? And will gold hold its value in euros or yen if the dollar continues to decline?
The short answer is no on all counts. The dollar price of gold does not increase with the US price level. And the value of gold does not increase in dollars to offset the fall in the value of the dollar relative to the euro or the yen.
Consider first the potential of gold as an inflation hedge. The price of an ounce of gold in 1980 was $400. Ten years later, the US consumer price index (CPI) was up more than 60%, but the price of gold was still $400, having risen to $700 and then fallen back during the intervening years. And by the year 2000, when the US consumer price index was more than twice its level in 1980, the price of gold had fallen to about $300 an ounce. Even when gold jumped to $800 an ounce in 2008, it had failed to keep up with the rise in consumer prices since 1980.
So gold is a poor inflation hedge. Moreover, the US government provides a very good inflation hedge in the form of Treasury Inflation Protected Securities (TIPS). A 10-year inflation-protected bond will not only provide interest and principal that keep up with the CPI, but also now pays a real interest rate that is now slightly more than 1%. And, if the price level should fall, a newly issued TIPS bond will return the original nominal purchase price, thus providing a hedge against deflation. Of course, investors who don’t want to tie up their funds in low-yielding government bonds can buy explicit inflation hedges as an overlay to their other investments.
Gold is also a poor hedge against currency fluctuations. A dollar was worth 200 yen in 1980. Twenty-five years later, the exchange rate had strengthened to 110 yen per dollar. Since gold was $400 an ounce in both years, holding gold did nothing to offset the fall in the value of the dollar. A Japanese investor who held dollar equities or real estate could instead have offset the exchange rate loss by buying yen futures. The same is true for the euro-based investor who would not have gained by holding gold but could have offset the dollar decline by buying euro futures.
In short, there are better ways than gold to hedge inflation risk and exchange-rate risk. TIPS, or their equivalent from other governments, provide safe inflation hedges, and explicit currency futures can offset exchange-rate risks.
Nevertheless, although gold is not an appropriate hedge against inflation risk or exchange-rate risk, it may be a very good investment. After all, the dollar value of gold has nearly tripled since 2005. And gold is a liquid asset that provides diversification in a portfolio of stocks, bonds, and real estate.
But gold is also a high-risk and highly volatile investment. Unlike common stock, bonds, and real estate, the value of gold does not reflect underlying earnings. Gold is a purely speculative investment. Over the next few years, it may fall to $500 an ounce or rise to $2,000 an ounce. There is no way to know which it will be. Caveat emptor .
Martin Feldstein, a professor of economics at Harvard, was Chairman of President Ronald Reagan's Council of Economic Advisors and President of the National Bureau for Economic Research.
Copyright: Project Syndicate, 2009.
www.project-syndicate.org
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jruspini 07:37 26 Dec 09
The smug pseudo-sagacity of gold critics is a bit maddening when it is coupled with a lack of basic research.
The 1980 numbers parroted here from CNBC are cherry-picked. If you choose an earlier starting date, basically any date when gold was freely traded, you will see that gold does keep up with inflation.
More to the point, *real returns* describe the historical performance of gold better than inflation alone. From memory, all of gold's appreciation post 1980 came in months where the real return was less than 3%, so you need to consider yields as well as inflation. Since gold has no positive yield, it is attractive when real returns are low. (Except when it is monetized, when it is attractive in deflation *or* when real yields are low.)
To the extent that long yields are being driven by bond vigilantes, then, yes, gold may not be attractive.
-- Jason Ruspini
Adamon 03:09 28 Dec 09
It never ceases to amaze me as I read numerous authors, including this, claiming that
"Moreover, the US government provides a very good inflation hedge in the form of Treasury Inflation Protected Securities (TIPS). A 10-year inflation-protected bond will not only provide interest and principal that keep up with the CPI, but also now pays a real interest rate that is now slightly more than 1%. And, if the price level should fall, a newly issued TIPS bond will return the original nominal purchase price, thus providing a hedge against deflation. "
The TIPS are taxed, the alleged protection against inflation IS TAXED. For somebody in, say, 28% taz bracket, a 5% "protection" is realyy only 3.6%. Amazing...
alexferro 08:52 28 Dec 09
I invite all you critics of the sound advice you got above:
1. Remove all the "pseudo- currencies" from the burial cans in your back-yards.
2. Use your pseudo-currencies to buy tin and lead.
3. Bury your tin and lead.
4. When hyper-inflatulation hits, I mean, hyper inflation hits, swap your tin and lead for all the world's gold and silver.
5. See - If you are the only person who took my advice and hoarded tin and lead now youll be the only person in the world having tin and lead.
a. ferro
shanethomas37 09:29 28 Dec 09
Je crois pour ma part que l'or est vraiment le placement à faire. J'ai lu sur le site où j'ai acheté de l'or, gold.fr, que l'or était une valeur refuge en temps de crise avec un très bon potentiel d'appréciation et je crois que les gens ne cherchent que cela, un valeur sûre pour s'y réfugier. Lorsque je vois le cours de l'or grimper, je me dis que d'acheter des 50 pesos mexicain fût une très bonne affaire.
fedupbook 12:59 29 Dec 09
Too long a comment to reply here, so I wrote my reply on my blog regarding the above article by Professor Feldstein:
Why Does Harvard Economics Professor Call Gold a High Risk, Highly Volatile Investment?
http://fedupbook.com/blog/gold/why-does-harvard-economics-professor-call-gold-a-high-risk-highly-volatile-investment/
Jayesh 02:31 30 Dec 09
Without fiat currency, all the big governments are in trouble and gold is questioning that basic idea of fiat currency. Understandably they want to discourage this new found love for gold. Who will finance their deficits?
Wall Street also hates gold rise. Who will come to zero sum game of stock market and loose their hard earned savings to them? ‘They’ all discourage and pull down gold whenever possible (remember CFTC's report on gold short sell financed by JP Morgan?)
But until wisdom to store some value of individual net worth in gold prevails, gold will do well. That wisdom is coming from ‘net saver’ societies and holders of ‘Big Money” as of now.
But yes, gold is not for greedy; it’s also not for some one who is jumping in it because of fear. It’s for those who see long term security. Net borrower societies will not understand purpose of saving for generations.
cheeheongquah 03:43 01 Jan 10
You could easily say those cause you have the benefits of hindsight.
Ex-ante, gold is a real commodity and no matter how the price deeps there is still a real physical value. On the other hand, no one can actually guarantee paper securities but of course they are largely risk-adjusted and are pretty safe. But, since the last banking crisis we know that paper securities are highly vulnerable and their market values could fall permanently.
The next factor is that as you mentioned, everyone can purchase gold easily with virtually no information and transaction costs. On the contrary, not everyone can buy into bonds without adequate capital and information. There are implicit costs involved.
In another respect, gold was the internaitonal medium of exchange and unit of account before and hence it is widely accepted and liquid, unlike the inflation-indexed securities.
Chee-Heong Quah, MYS
tevincarey 10:10 04 Jan 10
@shane thomas
Tu peux m'en dire plus sur le site où tu as acheté ton or? Comment procède-t-on? Parce que je veux faire vite et prendre ma part avant qu'il soit trop tard!
zwolf 03:25 06 Jan 10
You say gold has an intrinsic value. What might that be? At base, no one will produce gold if they're not paid something above its production cost. Let's just guess that's about $500 an ounce. I remember when it was about $300, but I'll concede that commodity production costs have gone up the last few years. Industrial demand is sparse as there aren't many applications. Jewelry demand is a perennial, but even that gets substituted away as the price rises. The moderately expensive watch I bought my wife is stainless steel inset with diamonds, something the septuagenarian salesman told me would have been gold and silver years ago.
Now let's pick a starting point to compare gold to other assets. Gold futures started trading in January 1975, which makes a sensible starting point, becasue that's the point from which you could actually trade the stuff. It also allows a couple of years for the state adjustment from controlled prices to free markets that began in 1971. There are only 2 sustained periods in the last 35 years that gold outperformed other assets: the late 1970s and the last few years. Both were periods of policy uncertainty.
Paul Volcker put paid to the 1970s uncertainty starting in October 1979. Gold peaked in January 1980 and drifted for almost 25 years. I suspect that gold, once again, will turn out to be a poor investment for many years. Invest in wealth creation by buying equities or wealth preservation by buying bonds.
S&P500 and bonds (Government / Corporate Index) have utterly crushed gold in US dollar return terms since 1975 (and for almost all other periods since gold and currencies floated).
Gold is very expensive insurance for tail risk. It's not something I'd bet my retirement on.
tevincarey 06:29 06 Jan 10
@tevincarey
Pour ton information, le site www.gold.fr est en fait le site internet du Comptoir national de l'or que l'on retrouve notamment à Strasbourg, je ne sais pas si cela te dit quelque chose. C'est simple. Tu n'as qu'à t'enregistrer sur le site puis choisir tes pièces. Après, ils te livrent ton or chez toi via circuit sécurisé. Tu peux aussi garder l'anonymat si tu le souhaites.
catfishkeller 12:44 26 Jan 10
I have been really interested in this subject recently and specifically cannot find much writing on exactly why gold has been valued by so many cultures and for so long. It's shiny, it doesn't corrode, and can easily be formed into many things ornamental and there is a finite amount of it on earth. But specifically why is, or should gold (or any precious metal) be used as a vehicle for transporting wealth? You can’t eat it, it cannot heal you, it cannot provide you warmth or shelter. Gold cannot be used as any type of fuel, it cannot be made into a sturdy tool or weapon. What is the tradition that makes it valuable? Is it truly just tradition? Please share with me any research or writing that any of you might have on the subject. But please do not send me to biased writing on why gold is or isn’t a good investment, just real social and anthropological research on the subject. Thank you.
Jayesh 01:51 26 Jan 10
I have many reasons why gold qualify to compete with fiat currency. But don’t you think that it has more to do with ‘qualification’ of itself but disqualification of the fiat currency. Everyone is seeking shelter from potential fallout. Gold is just a one shelter, there are many if one explores. We don’t have many experiences of currency collapses after moving away from gold standard but I can imagine it could be very painful. (Remember collapse of Russian rouble? I won't talk about Zimbabwe as it’s a bad comparison)
Irishman 05:13 04 Mar 10
Ah, Professor Feldstein, tell that to the residents of Zimbabwe who trusted their government's fiat dollars and are now starving because their fiat money is worthless. It is because I do not want my income and wealth to become worthless that I convert my dollars to gold as fast as I can. Can you point to an instance when a government has not inflated its fiat currency? 'Nuff said. http://www.jesus-on-taxes.com
wroth5 06:57 26 Dec 09
Gold is a hedge against, not changes in currency values or inflation, but rather the collapse of unsustainable fiat currencies (for example the soon coming nightmare in the US regarding unfunded Medicare and Social Security liabilities, the nationalization of the still deteriorating mortgage system, and unlimited support to an insolvent banking system).