Does Gold Preserve Purchasing Power?
One of the more controversial holdings of the Permanent Portfolio is Gold. Once you understand what gold can and cannot do you may understand a little better why the Permanent Portfolio holds some of it in the allocation.
Gold is a preserver of wealth that is compact and historically viewed as valuable. It’s not an investment in a traditional sense. If you want growth of your capital you should rely on stock investing and bonds. If you want preservation of capital, then gold can help by protecting you from high inflation or other unexpected events.
Gold in a portfolio is a way to take money off the investment gambling table and putting it away so you can’t lose it easily. Further, a couple attributes of gold that are unique is that it is impervious to political shenanigans which can affect a paper currency and it can be owned in a way so that it is nobody’s paper promise to you. As one gold dealer said: “Nobody ever went to the poor house buying gold.”
These are distinct features that stocks, bonds and cash do not have and is why it is important to hold some gold as part of any investment portfolio. Gold by itself will not grow your wealth, but it has an uncanny ability to protect what you do have when your other investments aren’t doing well.
In terms of protecting from inflation, gold is hard to beat and has a very long track record of preserving purchasing power. Let’s look at some historic prices to see how this works.
An ounce of gold in 1900 was officially set at about $20 an ounce (actually $20.67). Since gold and the dollar were the same (gold standard) a $20 bill or a $20 gold piece was about one ounce of gold (slightly less than one ounce actually).
We can look at historic prices and see what happens here:
http://www.gti.net/mocolib1/prices/1900.html
Let’s take for example a suit of clothes. This is the classic example of gold wealth preservation. Some historians have noted that one ounce of gold today would buy you a suit, a belt, a shirt and a pair of shoes. One ounce of gold in 1900 would do the same. One ounce of gold at the founding of the country would do the same. And some have said that going back to Roman times it would have bought the equivalent.
Obviously, the suits here are not the same so there is some price fluctuation. But I think the idea holds that one ounce of gold does preserve purchasing power. The prices for the suits and gold are from October of that year.
1900
Men’s suit, worsted, 7.00-16.00/each
One Ounce Gold: $20.67
1940
Men’s suit, tweed, 25.00/each
One Ounce Gold: $35
1970
Men’s suit, shaped double-breasted, wool, 56.95/each
One Ounce Gold: $35 * (in 1971 we broke the gold standard. This official price was too low. By 1972 the gold price shot to $65 an ounce essentially matching the prices from previous decades in terms of purchasing power.)
– Gold standard broken in 1971 – Gold allowed to float against the dollar and inflation went into the double digits.–
1980
Men’s suit, wool worsted, 425.00/each
One Ounce Gold: $661
(Note the price increase since 1971 when we abandoned the gold standard and inflation raged. )
1990
Men’s suit, Evan Picone, wool, 279.99/each (inflation finally under control)
One Ounce Gold: $380
2000
Men’s suit, 375.00-475.00/each
One Ounce Gold: $270 (who wants gold when you can own catlitter.com stock!!)
2007 (Price I paid a few months ago for some suits)
Men’s suit, $400-600
One Ounce Gold: (approx) $700
Keeping in mind that we don’t know the suit quality differences, if they included a shirt, how much the shoes would be, etc. I’d have to say that gold did what the advocates stated. It varied up and down through the years a little, but if you had that same one ounce gold coin from 1900 and walked into a store today you could purchase a modern suit with it and have some money left over. Gold in fact preserved purchasing power over this 100 year period.
Again, gold is not an investment in a traditional sense. It pays no interest or dividends. But if you want to have an asset that doesn’t lose value then the empirical data suggests that gold does work.
For these and other reasons the Permanent Portfolio holds gold as part of the mix. People are often critical of this asset, but in a balanced and diversified portfolio it can serve an important purpose along with stocks, bonds and cash in protecting and growing your money.
about 9 months ago
Hi Craig. I enjoy your blog, having lurked about. I have my doubts about gold. I can accept gold’s usefulness in preserving one’s purchasing power. But doesn’t it seem equally likely that the same hedge can be obtained using other hard/tangible assets (such as agricultural land, natural gas and oil royalty trusts, oil and gas pipeline MLPs or collateralized commodity futures). My problem with using gold is severalfold. First, it sports no yield. It has no return other than a speculative one. Second, it is not diversified. If one’s allocation to “inflation protection” were limited to gold, think about the risks to one’s return. Central bank selling or a change in fashion in India away from gold could really screw up the market. But the wider commodities market cannot be impacted in this way by some secular event.
I guess I feel like there are better, more diversified alternatives to the “barbarous relic.” For virtually any purpose in a portfolio I feel like there are other better choices. The only exception, I suppose, would be its use as currency after Armageddon (though in Max Max is was gasoline, in Waterworld it was land).
about 9 months ago
Hi Mark,
All good points. Let me address a few:
- Can other hard assets be used in place of gold for inflation hedging?
Sure they can. The problem is they’re not as liquid or easily stored as gold (you can’t sell off your driveway of your house to raise capital for instance). They’re also not as reliable. The other problem is you can have bull or bear markets in commodities and other assets that aren’t tied directly to dollar inflation (oil embargoes or oversupply, crop droughts or over supply, etc.). Since gold operates as a form of money for most banks and in the minds of most people it tends to react strongly to threats against the dollar. In 2008 for instance when the banking system was near collapse commodities lost about 50% of their value, but gold held fast. This is the monetary element of gold showing through. It’s a commodity, but it’s also money. You get the diversification benefit of both with gold that you don’t get with commodities.
- Gold has no yield, and can be speculative, etc.
Most hard assets fall into this category. Over time the only way to “make money” on gold and other hard assets is to rebalance religiously. You want to be buying it when nobody wants it and selling it when everyone wants it.
- MLPs, oil trusts, CCFs can replace gold.
I disagree with you here. Those assets have counter party risks that physical gold bullion does not. 75% of the permanent portfolio is in paper assets. 25% is in physical assets. This is a reasonable compromise between having absolute highest returns, yet still have some wealth tucked aside for a rainy day in a way that can’t be easily compromised.
- Gold is not diversified, banks can sell it, people may not want it any more, etc.
This is very unlikely. Gold is considered wealth in virtually every society and culture on this planet. It is ingrained in everything from religious texts, to everyday cliches. Gold is treated like money in almost every organized society on the planet. I’ve never been able to test it, but I’m pretty sure that if you held out some paper money from whatever country and a gold coin worth the same amount and asked which a person would rather have, they would probably choose the gold. If the dollar gets into trouble due to inflation (as the world’s foremost currency), then people will look for alternatives to put their money and gold is very high on the list and isn’t going away.
- Gold market can be screwed up by banks selling.
This is true and I hope they dump more of their gold. The Bank of England sold a pile of it when it was about $250 an ounce in the early 2000s. Their actions depressed the price of gold effectively subsidizing the purchases of others. Eventually they ran out of gold and the prices recovered. Then the prices went much higher. Banks selling gold is not a problem and eventually other banks will buy it back. Most countries want a reserve of gold because it is (even to them) an asset of last resort and a form of diversification for their own currencies or the US Dollar which many hold in reserve.
- Gold only good for Armageddon.
Not true at all. The 1970s had double digit inflation but no Thunder Dome. Yet the price of gold was able to go up sharply and protect purchasing power. The last 10 years have seen no serious Armageddon events but the price of gold outpaced stocks and bonds.
Again I’m not saying to be 100% in gold, but in a diversified portfolio it can and does work. You need to be sure you rebalance it and not get attached to it as the gold bugs often do.
about 9 months ago
Craig,
Those are excellent points. The issue most people miss when it comes to gold specifically and commodities generally is that it’s important to view this investment vis a vis a diversified portfolio. Looked at in isolation it’s true gold doesn’t pay dividends, or actually produce anything, but as part of a diversified portfolio (or in this case the PP), it works great. Especially if an investor rebalances.
I would be interested to see how the permanent portfolio has performed when rebalanced at the 30%/20% level rather than the 35%/15% level. I doubt you have this data, but it would be interesting to see.
Regards,
Ray
about 9 months ago
Craig, I’m just a schlep who has made a decent living starting up a decent business. I’m very interested in the permanent portfolio as a long-term strategy. I don’t have much experience investing outside of a vanguard IRA and a principal 401k account.
I would love seeing a post seeing how you address functionally how you manage your portfolio.
1) What is the he process in which you invest in physical gold? Is a certain percentage kept in a safe deposit box or do you hold everything in a registered vault?
2) The process in which you hold assets in an international account, as well as the asset classes held.
Do you combine the 2? Does it make sense to have your 25% of Gold all held offshore, for example, like in London or Switzerland? I assume that this cannot be accomplished within an IRA structure?
Also what challenges are presented when you are rebalancing out of t?
Do you hold some gold in an IRA? If so what brokerage are you using?
Everything I’m stumbling across in google searches seems very stilted (ie advertising a gold vendor or investment services).
I know there are lot of different outcomes here based on an individuals specific situation but I think it would make an interesting post if you laid out how you are managing your permanent portfolio.
about 9 months ago
Patrick,
You have too many questions for me to address in a comment section. Let me give a short response.
Harry Browne advocated holding gold bullion. This has some logistical problems when you reach a certain level. In general, you should hold some gold bullion coins that you can closely control in a safe location such as a safe deposit box or other area you know is secure. These are assets that you can have “just in case” you needed to get to them quickly.
Then comes a time when you simply cannot hold the gold in such a way. For instance someone with a very large portfolio probably wouldn’t be able to stuff hundreds of thousands of dollars worth of gold into a safe deposit box easily. At this point, you probably need to work with a bank that can handle this for you in a secure manner.
Harry Browne advocated keeping some gold in segregated storage in a safe country like Switzerland. Unfortunately since his death in 2006 many things have changed and it has become much harder for Americans to work with overseas banks.
My conclusion now is that I don’t have a good answer for you. The situation is changing fairly rapidly and I don’t have a solid workable option for people who want to store gold offshore. There are some services that are claiming to do this for you such as goldmoney.com and bullionvault.com. I have no experience with these services, but others have been using them and claim they are working fine. My main concern is how the gold assets are insured, protected, and how your claims against them are handled. But perhaps this is not such a great concern considering the alternatives right now.
Don’t hold gold in a retirement account if you don’t have to. For one, you are wasting space because it has no interest or dividends that need sheltering like bonds, cash and stocks. Secondly, gold is an asset of last resort and you don’t want a bunch of people and pieces of paper between you and it if something bad were to happen in the economy.
about 8 months ago
Craig thanks for the thoughtful reply. I spent much of yesterday reading through the long Bogleheads thread on the PP and came to the same conclusions.
I like the idea of holding something I can liquidate offshore but I don’t think I have enough value to warrant taking a trip to Zurich and paying for a custodian to hold it for me.
GoldMoney and Bullionvault are both so new that I’m leery – seems too good to be true. It I might feel different if I could walk in and see it. Odd that I feel this way about gold but not other assets. But it does seem like it would make rebalancing very simple with a service like this, especially if you were all/mostly taxable. I’m not keen about driving with a couple thou worth of golden eagles to a shop across town when I would need to rebalance, shipping it out insured ,etc.
At any rate I think I’ll hold my initial locally and keep researching offshore.
This blog and the bogleheads thread were so educational. I’ve started listening to the HB money talk shows as well.
This all addresses a lot of concerns/thoughts I’ve had with asset allocation/diversification over the past few years in a nice package, and really cuts out a lot of the management fees that have been gnawing at me.
PS a nice blog feature would a notification of new comments to a thread – JD has something similar up over at Get Rich Slowly.
about 8 months ago
Patrick,
I’ve installed a plug-in that will allow you to subscribe to comments. Also you can subscribe to the RSS feed of a comment by clicking the link at the top of the comment thread.
about 8 months ago
Thanks again Craig. I hope you’re working on a Gold post in your FAQ. I spent some time Monday reading through old comments and you braindump a lot of useful nuggets through out other posts here.
Your knowledge is an incredible resource.
about 8 months ago
Hey, a new gold purchasing alternative is available in Deutschland:
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/5554972/Gold-sold-like-chocolate-from-German-vending-machines.html
about 5 months ago
A way to hold gold is in Exchange Traded Funds GLD or IAU
In a taxable account the gains are taxed at your ordinary rate. In an IRA they are sheltered.
If the choice was a stock fund in a taxable account or a gold fund with the other in an IRA I would put the gold fund in the IRA
about 5 months ago
Jan,
No good choices here. The main argument for holding stocks vs. gold in the shelter is the gold doesn’t have interest or dividends that need to be sheltered constantly. You only pay gains when you sell. The other problem with gold in the IRA is you lose access to it as it must be held by a custodian. This is an issue for those that want closer control of physical bullion such as in a bank.
about 5 months ago
There is a LOT of slippage in owning physical gold and buying and selling it. The transaction costs are MUCH less buying and selling GLD or IAU.
Just like you want a local bank account or checking account so you have instant access to funds, if it is an issue for you a few gold coins can be held in a wall in your house. If I had that mentality though, I would stock up on soap, toothpaste, toilet paper, and cigarettes. They will have more value when the world is going to pot. People will not want gold at such times but be looking to buy something with the gold.