Any asset can beat another in the short-term but does gold perform well in the long run compared to stocks. I have a feeling that goldbugs will permanently delete this blog from their bookmarks after reading this post ;) Reader hpmst3 wondered about something he read about gold:
On another topic, I read that over the past 40 years, gold has returned 8.4% annualized versus the S&P 500's 9.1% annualized. This was in the wsj, and the author was quoting a money manager from Cincinnati. I was shocked. I thought that Gold's return was a lot lower like around 2 or 3% annualized. I don't know what they were using as a benchmark since ETF's were not around. I am guessing that they used the commodity itself. I have seen you write about gold before. Do you by any chance know if this is correct Sivaram?
The numbers are correct. I calculated the numbers and they are very close (any differences are likely due to slight differences in time period, annual vs daily price changes, and rounding error.)
Gold is indeed one of the worst investments during the long run. Its return is very close to cash/money-market-funds. However, the period that is picked (last 40 years, which is also roughly when USA went off the gold standard (in foreign dealings)) makes gold look better than it generally is. The chosen starting point matters very much.
Starting Point Matters
Fourty years would place the start close to when USA ended the gold standard (USA went off the gold standard in 1971). The fixed value of gold was severely undervalued by the late 60's, and gold rallied when the US$ went off the gold peg. Conversely, stocks had a terrible period starting in the early 70's. If you move the date further back (say to the 40's) or further towards the recent (say the late 70's), then gold would not post such a great return.
Furthermore, stocks are close to a trough in valuation right now. Although I think stocks are not cheap and can fall another 30% to 50%, I view stocks as being closer to the bottom than the top. Any comparison right now would look at a period when stocks had one of the worst bear markets while gold had one of the best bull markets. This is similar to the criticism I made a while back on notion thatbonds have outperformed stocks for the last 40 years: you are basically picking a trough for stocks and a peak for bonds. Strictly from a contrarian point of view, stocks are far more attractive now than gold. (None of this should be taken to suggest that stocks are a good investment right now per se. Rather, my view is that stocks will likely outperform for the long-term, going forward.)
In any case, let's look at what actually happened.
Gold vs Stocks: 1900 to Now
How does gold compare to stocks?
The charts below plots average annual gold prices against the average annual S&P 500 index (scaled) with dividends excluded since 1900. The data comes from the World Gold Council (if you ever need gold statistics, head over there—requires free registration) and Crestmont Research. These charts also plot the average annual price and index level so they may differ slightly from daily values (for example, gold hit a daily peak in the US$800's in 1980 but the annual peak, which is what I plot, is only $615.)
I wish I had the S&P 500 chart including dividends but, alas, I don't have access to any so I have to go with the price index. However, I do list the annualized return including dividends (I calculated these and there may be some rounding errors and some minor discrepancies.) The S&P 500 numbers are scaled to those of gold. That is, S&P 500 starts at the same value as gold in order to facilitate comparison, so the S&P 500 numbers do not represent the actual index numbers. As usual, click on the chart for a more legible picture.
As you can see, stocks had a spectacular rally recently, followed by two catastrophic collapses. Gold essentially catches up to the S&P 500 in the last 10 years. The charts are useful it getting a rough feel for how things worked out in the past. One should really use the annualized numbers, which are more precise, to compare against gold.
It's kind of hard to see the details from this chart, so I also plotted the same graph with a log scale:
This isn't much of a battle. Stocks leave gold in the dust. Since 1900, gold posted a 3.5% annual return whereas stocks posted 5% per year without dividends and 9% with dividends. Since only the stock prices are plotted, at least gold sort of keeps up, trailing badly. If one plotted a chart including dividends, the gap would be so large that it would be like a contest between a snail and a cheetah ;).
To get real returns, I typically subtract 3% for inflation. For stocks and bonds one may also want to subtract 1% for transaction costs (Crestmont Research, in their stock matrix, uses 2%). If you subtract 3% from gold, you get a real return close to 0%. This is consistent with what one should expect. Gold doesn't create any wealth*; it simply preserves it.
Gold vs Stocks: 1970 to Now
So far it seems gold doesn't do as well as the original quote indicates. But how about in the last 40 years (or thereabouts)? I have plotted the same chart as above, but for the period covering 1970 onwards. I chose this period instead of exactly 40 years simply because it was easier; the results wouldn't change if someone started in 1969.
The story is drastically different in this time period. As you can see from the chart, gold actually surpasses the price chart (which excludes dividends) that is plotted. If you include dividends, gold still underperforms stocks but it is close.
From 1970 onwards, gold posts an annual return of 8.3%, whereas stocks post 6% and 9%, without and with dividends, respectively.
So, what hpmst3 mentions is correct. My numbers are slightly off (possibly due to rounding errors, annual vs daily price change, S&P 500 estimate, etc) but they are consistent with what was quoted at the beginning. A gold investor performs almost as well as a stock market investor in the last 40 years. This, for an asset that doesn't even pay interest or a dividend!
So is gold a better investment right now? I would say no, unless you were in the high-inflation or hyperinflation camp. Gold looks good because it is near a peak while stocks are near a trough. In 10 years, I'll bet that stocks will have outperformed gold for the 1970 to 2019 period. In fact, if stock prices stay flat for the next 10 years, they will match gold simply because their dividend yield is 3% (assuming no cuts). Gold generally returns 3% per year, which is roughly the long run inflation rate, and a 3% dividend yield on stocks will match gold's performance. Of course, this is just a rough estimate and if you incorporate your macro outlook and valuation judgment, then stocks may outperform or underperform. For instance, someone who expects high inflation will be certain that gold will post way more than 3% per year going forward. In contrast, those leaning towards deflation will be shocked if gold even returns 3% (it should actually return 0% or even negative, assuming you start with gold at neutral/fair-value.)
So, hopefully that answers the question. Thanks for asking the question because it is a good one. I had to spend some time on this post but it was a good learning for me as well.
The analysis here clearly goes to show that some assets can outperform during long periods even if they have lower very-long-term returns (this is one of the key thrusts for macro investors, who tend to invest in anything, even if the asset has poor long-term return.) One should never assume that stocks always outperform even though no other asset comes anywhere near stocks in the long run. It's possible for stocks to underperform for long stretches.
My opinion right now is that stocks are neither cheap nor expensive. I view gold as being overvalued and closer to any peak than a trough. But, unlike stocks or bonds, gold has no intrinsic value and is driven by sentiment and other non-quantitative factors.
* Gold doesn't create wealth. If it did, then a few hundread years ago, the Spanish, who had a lot of gold and silver, would have been more prosperous than the Dutch, who had very little gold. Yet, the Dutch are considered more successful and to have increased their wealth more than the Spanish. Investing in stocks versus gold is similar. If you invest in gold, you are flying the Spanish flag and if you invest in stocks, you choose to bet your money on the Dutch. The Spanish, in the time period I am referring to, retained a lot of their wealth but they never really increased it much. Similarly, if you put 50% of your portfolio in gold, I am certain that it will maintain its value in 100 years (unless gold becomes obsolete or loses its monetary nature). But you won't increase it either... If you are wealthy, you should probably hold 5% in gold bullion, just to preserve wealth even if the whole world falls apart. But if you are not rich, like me, then gold is a drag**. I will probably live my life without holding any gold as a long-term investment (but I can see myself making a medium-term macro bet on gold.)
** I am not a passive investor and most of what I write has nothing to do with it. But if you are a passive investor who uses a diversified portfolio model and believes in efficient markets (i.e. doesn't believe one can beat the market, or at least predict anything), you can actually increase your portfolio returns by adding gold. Historically (pre-2005 or thereabouts), gold has had a zero to very-low correlation with stocks. According to basic portfolio theory, adding such an asset, even if it has lower expected return, boosts your portfolio return. In addition, William Bernstein has suggested that you can significantly boost your returns by rebalancing gold stocks: "...rebalancing precious metals equity allows one to extract the arithmetic return out of the geometric return." I don't use a diversified portfolio or rely on passive investment strategies so I'm not going to comment further. If you are into it, you should read up on it (other historically lowly correlated assets include timber, frontier markets, and I also believe art & collectibles.)