Does Gold Outperform Stocks Over the Long Run?

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There’s a financial meme out there that suggests gold and silver have outperformed stocks over the past 20 years. The chart looks something like this:

Gold line = gold
Silver line = silver
Blue line = Dow Jones Industrial Average (DJIA)
Red = S&P 500

Looking at this chart, one might come to the conclusion that gold and sliver outperform stocks over the long run. However this conclusion is incorrect.

First of all, the relative performance shown in the chart is very sensitive to start and end dates. For example, if the chart goes back an additional 10 years the outcome completely reverses with stocks outperforming gold and silver:

Alternatively, if I shift the 20 year period to 1959-1979 gold and silver’s out-performance is dramatically amplified.

The point I’m trying to make is that the relative performance of gold and silver is highly dependent on the time period in question. In other words, the performance of precious metals changes with the economic environment. One cannot judge long-run expected returns for gold and silver based on any single period alone.

The next point I want to make is that these memes often make the mistake of comparing gold and silver against the price returns of various stock indices. The charts above use the price returns for the DJIA and S&P 500. Price returns don’t include dividends and therefore provide an incomplete picture of the actual returns from holding stocks.

Below, I’ve re-created the charts and added a black line that represents the total returns provided by large cap stocks (using the Wilshire Large Cap Index back to 1978 and S&P 500 Total Returns Index prior to 1978). While the price return for S&P 500 (red line) was 129% over the 20 year period, the Total Return (black line) was 240%. Gold and silver still dramatically outperformed during this 20 year period.

Like in the previous example, extending the history to 30 years flips the script. While the price indices outperform (as they did in the earlier example) the new total returns line dominates. The added compounding effects of dividends becomes increasingly noticeable as time goes on.

The farther back you go, the more impactful the compounding effects of dividends become. The following chart compares 100 years of returns, with the total returns index being the clear winner, while gold, silver and price return stock indices barely register.

Today, we could be in a period in which gold and silver outperforms stocks. This out-performance is highly dependent on the prevailing economics, such as negative real yields and currency depreciation. There are so many factors that nobody really knows for sure.

I personally believe a strategic allocation to gold can help improve portfolio risk-return characteristics. I also believe that we might be in an economic environment in which gold outperforms stocks. However, to extrapolate the out-performance of the last 20 years to argue that precious metals should provide higher expected returns over the long-run is misleading.

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5 Must See Gold Charts

In over night trading on July 27th, gold broke through its all time high reaching over $1940 per ounce before retreating. We are in the middle of a dangerous monetary experiment and the world is waking up.

Gold could be in the middle of a monster move. I recently wrote an article on Seeking Alpha showing how gold could go as high as $3465 based on its relationship with M2 money supply.

The recent rise in gold is a mirror image of the dramatic decline in the US dollar.

What really drives the price of gold? Real yields. The following chart plots real yields (inverse) against the price of gold. As real yields decline (show by a rise on the chart) gold prices rise. (Read more about it here.)

Annual purchases of gold ETFs highest in 15 years. And 2020 is only half over.

Still think gold is a barbarous relic that has nothing to do with the monetary system? Well, central banks around the world have been accumulating gold reserves since the 2008 Global Financial Crisis.

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The Covid-19 economic crisis is gripping the world. After 20 years in the asset management business, it looks like we are fighting through unprecedented territory.

This is war. I created a 17 step, 47 page guide to help DumbWealth subscribers get through this.

I originally planned on printing the guide and selling copies for $20+. Instead I’m giving this away free because I think we all need to help each other during these difficult times.

Investing Wealth

What Drives Gold Prices?

As a monetary metal, gold has been with humanity for thousands of years. Its role as a safe haven for wealth has been generally understood throughout time. Historically gold was simply another currency – one that couldn’t be debased and could reliably store vast amounts of wealth.

When thinking about gold, one must separate its value from its price. The value of gold is fairly stable. When compared to fiat currency, gold prices will fluctuate over time, but this is not because the value of gold is changing. Rather, it’s because the fiat currencies are appreciating or depreciating. For this reason, it’s important to analyze gold in terms of your home currency, despite it being most frequently quoted in USD. For example, the price of gold in USD might be stable but for a Canadian investor it might be rising because the value of CAD is declining. This relationship to currencies is an important first step to understanding what drives gold prices.

Many people believe inflation drives the price of gold. While this might be partly true (because inflation increases the value of tangible assets), it is inflation’s effect on currencies and investment alternatives that actually makes gold more attractive to investors.

Inflation will cause a country’s currency to depreciate relative to other currencies. As previously explained, in such a circumstance the gold price will rise in relation to a declining currency.

Equally important, inflation erodes the real returns provided by assets like stocks and bonds. In particular, safe havens like US Treasuries may provide a very low or even negative real yield when inflation is high enough relative to nominal yields. (Real yield = nominal yield minus inflation.) Importantly, this condition doesn’t require high inflation. Simply, inflation only needs to be higher than nominal interest rates.

Gold competes in many ways to US Treasuries as a safe haven. If investors can receive a positive real return on US Treasuries they are less likely to use gold – which provides zero yield – as a safe haven. The higher the real yield, the worse non-yielding assets look in comparison.

In contrast, when real yields on US Treasury bonds are negative, investors actually lose by holding them. A zero-yield actually becomes more attractive at that point.

Most gold bull markets have occurred when real yields were falling, low or negative. Gold bear markets tend to occur when real yields are rising, high or positive.

The Chart 1 below compares 1yr US Treasury yields (black line), inflation (red line) and real yields (blue line) going back to 1970. In Chart 2 below shows gold prices over the same period. As you can see in the first chart, real interest rates were falling, low or negative during the 1970s, but then began to rise around 1980. From 1980-2000 real interest rates remained positive and relatively high, until they began to decline at the turn of the century. Between 2000-2011 real interest rates were low and negative for most of the time. Leading into 2011, real interest rates began to rise and peaked around 2015. After 2015 real interest rates moved sideways again spending much time in negative territory.

How did gold perform during these periods?

1970-1980: Gold bull market
1980-2000: Gold bear market
2000-2011: Gold bull market
2011-2015: Gold bear market
2015-Present: Gold bull market

Chart 1: Nominal Yields, Inflation, Real Yields
Chart 2: Gold Price

While negative real yields might seem like an economic rarity, they occur quite frequently. As a matter of policy, negative real yields are often associated with periods of financial repression when governments are attempting to climb out from under the weight of oppressive debt levels. Essentially, when yields on government debt are less than inflation governments are able to ‘inflate’ their way out of debt. Because of inflation, the value of government assets and tax revenues are able to rise faster than the value of government liabilities and interest expense.

What does the future hold for real yields and gold?

While the world is currently working through a deflationary shock due to the Covid-19 shutdowns and collapse of demand, the monetary and fiscal response may push up the inflation rate and push down yields.

Note: I realize that the last time policy makers expanded the Fed balance sheet it failed to create any meaningful inflation. Long story short, I believe this time might be different because the US Treasury is increasingly involved, corporate debt is effectively backstopped by the Treasury and private banks are therefore much more willing to lend (thus increasing the money supply) than during previous crises.

Massive – and quickly growing – public and private sector liabilities have cornered policy makers. The only escape is secular financial repression to erode the real value of debts. Another option – default on debts and entitlements – simply isn’t politically palatable.

Therefore, it is reasonable to expect real yields to remain low-to-negative at least until the economy recovers from the current economic crisis. However, since debt loads are growing massively because of the crisis I can’t see any alternative but financial repression for at least a few years. Using the 2008/2009 global financial crisis as a rough guide, we may be recovering from this for years to come. the current gold bull market could last a few more years and gold prices could double from today’s levels.

Important note: I don’t have a crystal ball. Also, forecasts change as economic circumstances evolve. So don’t read this article and think you can set it and forget it. With an investment like gold that is so fundamentally different from the more traditional long-term asset classes, you must track the changing environment and adjust accordingly.