Friday, February 8, 2013

Value of gold: is this time really different?

Why is gold valued? is year in year out one of the most visited posts on this blog. For some reason that I still cannot fathom people care a lot about the value of gold. The fact that is does not have much fundamental value except for what people believe it is worth makes it almost as much a fiat currency as the money doom sayers want it to replace. Another repeated myth about gold is that its value is stable or can only go up, despite the fact that there have been some spectacular drops. Like now, where people claim that this time it is different, gold is the best refuge in the face of a major meltdown of various currencies. Or at least as a hedge against pending inflation.

Claude Erb and Campbell Harvey explore the role of gold as a hedge against inflation. It turns out gold is a very poor hedge, and if it were, it should be at half its current price. I guess this over-reaction can be attributed to herd-behavior, which nowhere as common as for gold. And with the real price of gold at twice the long term average, and the fact that mean reversion invariably kicks in, sooner or later the price is going to go significantly down. Always has, always will. This time is no different.

If gold has a useful property, it is a very good hedge against inflation in the very long run. We are talking centuries here. Erb and Harvey compare the pay of Roman and US soldiers in gold and find that they are remarkably similar. But this means also that gold does not have returns that are in any way comparable to equity. We are taking here about returns that are a small fraction of a percent. Hardly a good investment. Also, gold is no good currency hedge either, as its fluctuations are so big that they drown out the fluctuations in exchange rates. Etc. Erb and Harvey go through a series of other arguments why gold should be held, and none seems to hold water. But gold is shiny.

4 comments:

Anonymous said...

Let's assume, for a moment, that you believe the expected volatility of the long term price level will rise.

Given the wider range of outcomes, its hard to know whether bonds will deliver a real return. You could buy stocks or other risk assets, but their real return is negatively correlated with price level volatility. You could buy the currency of an issuer with stable price level volatility expectations. If you could find none, what would you buy?

Again, I'm not asking if you agree with the premise on the price level. I'm asking what you would buy if you did.

Economic Logician said...

For one to buy gold in such circumstances and the current gold price, one would need to expected volatility at level dramatically higher than anything experienced in history. Gold is not the solution, and especially now.

Anonymous said...

The free download version of the paper is available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2078535

Anonymous said...

Economic Logician,
The question remains: what would you buy if you expected the volatility of the long term price level to rise?