Are any of the gold ownership myths true?
Myths are usually perpetuated by constant repetition, the drawing of symbolic connections, and a neglect of the actual facts. These are the stuff of which the myths about the investment benefits of gold are made.
In some cases, the myth involves a contradiction in terms – as does the myth that gold should be held as a hedge against currency fluctuations. This either means merely that gold is a hedge against inflation, or that it is a hedge against fluctuations in one particular currency.
If it is intended as a hedge against a fall in one’s own country’s currency relative to other currencies, then it is an asymmetric argument. As Erb and Harvey say: “If the price of gold in a country is driven by its own inflation rate, and if the exchange rate between two countries is driven by the difference in their inflation rates, then gold will only reliably be a hedge of the foreign exchange rate if one of the two countries always has an inflation rate equal to zero.” That is, the notion of gold as this type of hedge attributes a stability to the other country’s currency that is in doubt in one’s own. If that is in fact the case, holding the other country’s currency should do the job at least as well as holding gold.
Furthermore, evidence presented by Erb and Harvey shows that the price of gold in all major currencies has fluctuated from 1975-2012 much more than their exchange rates. Hence, over that time (the only period of record with floating gold prices), holding gold subjected the owner to more risk than merely holding the wrong currency.
Erb and Harvey dispense – in part – with the argument that gold is a “safe haven” by using an amusing anecdote. In the British Museum in London is a collection of Roman gold and silver coins from the fifth century known as the Hoxne hoard, named after the village in England in which the buried hoard was discovered in 1992. The presumption is that the wealthy family that originally owned the hoard didn’t have time to dig it up and take it with them when they had to flee. Gold as a “safe haven” is neither liquid nor portable; what then can the term “safe haven” mean? If it isn’t an asset that you can take with you or liquidate in a pinch then how is it a safe haven? Once again, perhaps what the proponents of this argument really mean is that gold is a hedge against inflation.
As for the argument that gold is a de facto world currency standard, it is hard to see how that is true. It is not the official standard in any country and has not been officially convertible to a currency since Switzerland ended convertibility in 2000, and it is not in any sense a de facto standard, since it is very rarely either accepted or offered in trade for goods and services.
Except for the claim that gold is “under-owned,” Erb and Harvey find that each argument is merely the argument that gold is an inflation hedge in disguise.
Is gold a hedge against inflation?
Since most of the arguments boil down to the claim that gold is a hedge against inflation, let us scrutinize that claim more deeply. All empirical investigations about the price of gold are limited by the fact that the market price track record dates only to 1975, but that price history is informative nonetheless.
Erb and Harvey explore whether gold can hedge against unexpected inflation by investigating whether gold price changes correlate with changes in inflation rates, on the assumption that next year’s expected inflation is this year’s inflation. If year-to-year gold price changes correlate with inflation rate changes, then gold could be used to hedge against unexpected inflation. But Erb and Harvey find no such correlation. Their conclusion is that gold does not hedge against unexpected inflation in the short run.
In the long run – 10-year periods – trailing annualized gold returns have fluctuated much more widely than inflation rates. “There has been substantial variation in trailing 10-year annualized gold returns: from as low as -6% per annum to as high as +20% per annum,” Erb and Harvey write. “Over the same time period, the low and high inflation returns were +2.3% per annum and +7.3% per annum. [This] suggests that gold is not a very effective long-term inflation hedge when the long-term is defined as 10 years.”
Why, then, did I mention that Erb and Harvey present evidence that gold is a hedge against inflation in the very long term? That is because they do discover intriguing facts about the price in gold of human labor over historic time. These facts are curiosities of interest to students of economic history, but they are not relevant to investors.
Erb and Harvey unearthed a 1992 article by M. Alexander Speidel in the Journal of Roman Studies, titled “Roman Army Pay Scales.” It turns out that the pay rate in gold for military staff of the Roman legion during the reign of the Roman Emperor Augustus, 27 B.C. – 14 A.D., was almost precisely the same as the equivalent in today’s gold price of current pay for soldiers in the U.S. Army.