Being wealthy doesn't mean having all the money in the world, just not having to worry about it.

Lesson 16 – Fool’s Gold

If you’ve ever Googled my name, you undoubtedly know that I’m a libertarian. In fact, way back in 1982, I was the Libertarian Party nominee for California treasurer. I didn’t win, but I got an extremely high percentage of the vote in all marijuana-growing districts (which is rather odd since I may be the only Berkeley graduate to never smoke pot).

I will be the first to admit that there are a lot of “interesting” characters who populate the libertarian movement. In the 1970s, one of those groups was the Gold Bugs. I’m not talking about reasonable advocates of a return to the gold standard in monetary policy. I’m talking about people who told everyone to sell all their stocks, all their bonds, and all other paper promises and invest in gold, guns, and farmland. And then wait for the Apocalypse.

They could be right, of course, although I suspect the ones with the gold will be the first ones beaten to death by the mob. And if there is ever a global loss of confidence in the U.S. dollar, I wouldn’t be surprised to see a new currency arise based on the gold standard. But as an investment, or even as a hedge against inflation, it stinks.

In the last lesson I mentioned that the 67% real loss in Treasury bonds over the four decades-plus ended some time in 1981. Just before that decline ended, gold began a two-decade drop, which brought its dollar price down by 68%, while the cost of living doubled (some hedge against inflation, eh?), so that the real loss was 84% for the two decades or so ending in 2000.

So let’s look at gold through the PIG (Preservation, Income, Growth) lens.

P – For much of history, gold WAS money. So it preserved purchasing power almost by definition. But its wild swings in value since the end of the gold standard in America clearly don’t fit the meaning of preservation of value to most people today. Since you can’t eat, wear, or live inside of gold, but need to exchange it for food, clothing, and shelter, you’d be better off buying food (hence the farmland), clothing, and shelter (hence a cottage on the farm) directly if your goal is preservation of your standard of living. I’m not much into farming, but owning a home is not an unreasonable thing to do (except during a housing bubble).

I – Income? We ain’t got no income. We don’t need no income. I don’t have to show you any stinkin’ income! (You might remember that the name of the Mexican bandit leader in The Treasure of the Sierra Madre was Gold Hat.) Gold doesn’t pay any income.

G – Over long periods of time, whether that means the period since the Federal Reserve System started inflating or the history of the United States, the value of gold has risen at around 1% above inflation (or deflation) because of overall increases in the productivity of society and, thus, the quantity of goods available in exchange for gold. Unfortunately, exchanging gold for something else is a taxable transaction, so that gold, like Treasury bonds, is lucky to earn a return of nothing after inflation and taxes.

So if you figured I hated Treasury bonds because I’m a libertarian, you now know better. I like gold even less. Once again, however, I’m guilty of a straw-man argument because few people are considering putting everything into gold (unless they need to flee for their lives). Might it also offer a diversification benefit in a stock portfolio? Yes, again.

So let’s talk about the use of Treasuries and gold (and perhaps other items) as insurance during periods of stock-market panic, which requires us to first discuss the theory behind insurance in general. Our next lesson.