Week 253 - Gold

Situation: For many of us, our concept of personal financial security meshes with our concept of personal safety. Recent TV commercials highlighting the benefits of owning gold are a case in point. The idea is that an investor may not need to worry so much about government debt, and its effect on inflation, if his or her retirement plan includes a “Gold IRA.” Given that the IRS classifies gold as a “collectible” (because it doesn’t pay interest and can’t be rented), its dollar value is defined by the eagerness of prospective owners, i.e., gold’s value increases only if there are more buyers than sellers. The main reason to buy into a “crowded trade” is to hedge against the likelihood of a future event that would negatively affect the buyer’s personal financial security.  

One possible event is that the US government’s debt per capita would increase to the point of “currency debasement.” The more people become concerned about that possibility, the more valuable gold becomes. The fact that the US government’s debt per capita has been falling since the Great Recession doesn't remove this concern. Why? Because the US government is increasingly seen as the “payer of last resort.” For example, Puerto Rico is no longer solvent and needs an $80B bailout. Another example: thousands of municipal water systems have lead pipes that urgently need replacing. Finally, such a large number of senior citizens (“baby boomers”) are retiring that Medicare expenditures will increase dramatically. 

To sum up, there is too much government, corporate, and household debt worldwide. The tendency of Central Banks to drive interest rates ever lower (to “jump-start” their economies) only makes borrowing more attractive, and the likely result of that will be greater indebtedness.

Mission: Look at 12-yr returns for GLD, an exchange-traded fund (ETF) for gold bullion, as well as the Market Vectors Gold Miners ETF (GDX) and Newmont Mining (NEM), the largest US gold miner. Two other large mining companies are also important to consider: Agnico Eagle Mines Ltd (AEM) and Barrick Gold (ABX). Gold mining is accomplished by getting rock out of the ground and using massive electric-drive Caterpillar (CAT) trucks to carry it out of the mine. That stock’s price is a good barometer of mining activity. It is also important to consider the only Dividend Achiever among gold stocks, Royal Gold (RGLD), which is a company that obtains royalties on gold production in exchange for financing gold mines. Compare those returns (see Table) to more typical US stocks in the commodity space, such as NextEra Energy (NEE), Union Pacific (UNP) and Exxon Mobil (XOM). 

Bottom Line: By owning gold you’re giving up the opportunity to make another investment that provides you with a steady income from interest, dividends or rent. You also miss out on paying the low capital gains tax for income-producing investments. Gold is a “collectible” and the proceeds are taxed as income. This may not matter, if you think hyperinflation is a looming threat. Just remember, gold is the most speculative of investments because of its price volatility and lack of income. 

Risk Rating: 10

Full Disclosure: I dollar-average into NEE, UNP, and XOM.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).

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