Gold’s underperformance in the stock market is nothing new. Since it became legal for individuals to trade in January 1975, it has significantly underperformed the return on the S&P 500 index on an annualized basis: 5.2%⁽²⁾ versus 12.2%. The stock market is likely the superior option for those who are concerned about inflation.

Gold as a Currency Hedge

Investors concerned about potential weakness in the U.S. dollar could be better served by diversifying their portfolio globally. Declines in the dollar translate into a gain for U.S.-based investors who purchased assets in a currency that later appreciated. As with U.S. stocks, gold has substantially underperformed international stocks since 1975⁽³⁾: 5.2% versus 9.9%.

Gold as a Hedge Against Geo-Political Risk

Bonds may be better than gold in a flight-to-quality scenario. When geo-political fears or other risks surface, investors want to ensure they are sufficiently diversified. Gold can effectively accomplish this task. The correlation between gold and stocks since the year 2000 is +0.09. Such a low correlation implies that the typical ebb and flow of stock prices has little bearing on the price of gold. High-quality Treasury bonds, however, take the diversification benefit a step further. Over the same period, the correlation between intermediate-term Treasury bonds and the S&P 500 was -0.19. Here, a negative correlation means that when stocks fall, bonds tend to rise. This is a particularly attractive feature during periods of market volatility.

Conclusion

The superior returns generated by the stock market arise from the fact that businesses generate cash flow that can be reinvested. Reinvestment allows these companies to expand their operations, which increases their ability to generate even more cash flow, and so on in a virtuous cycle that has been a miracle of wealth creation. Gold, on the other hand, does not generate earnings or anything else of value. Its ability to deliver a return rests solely on the belief that somebody in the future will be willing to pay you more than what you originally paid. 

Warren Buffet shared his thoughts on the subject in the 2011 Berkshire Hathaway shareholder letter:

Today, the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually) plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

A century from now, the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops, and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

There is nothing to say the price of gold cannot increase significantly from here, particularly with a new crop of retail traders ready to pile into any asset with momentum. The bottom line, however, is that gold should not be counted on to generate long-term wealth as well as stocks or to diversify stocks as well as bonds. There can and will be periods where gold outshines other asset classes, but its inability to produce anything of value ultimately limits its value. Long-term investors are better off sticking with a diversified portfolio of stocks and bonds. 

1. Claude B. Erb & Campbell R. Harvey (2013) The Golden Dilemma, Financial Analysts Journal, 69:4, 10-42, DOI: 10.2469/faj.v69.n4.1
2. Based on the gold spot price and the S&P 500 Index
3. Based on the gold spot price and the Fama/French International Market Index

Week in Review

• The Bureau of Labor Statistics (BLS) recently provided an update on the Fed’s progress against inflation when it published the April Consumer Price Index (CPI). For the first time in a few months, the data was in-line or lower than economists were expecting, with CPI rising 0.3% from March and 3.4% from the prior year. Core CPI, which excludes the volatile food and energy categories, also rose 0.3% month-over-month and 3.6% year-over-year, the lowest year-over-year reading since April 2021.
• The S&P CoreLogic Case-Schiller 20-city price index, which measures home prices in the largest 20 U.S. Metropolitan areas, hit a record high in March 2024 and rose 6.5% year-over-year. This occurred as mortgage rates (as measured by the average 30-year fixed rate mortgage in the US) stayed between 6.7% and 6.9% throughout the month. As of the time of this writing, mortgage rates briefly eclipsed 7% in early May and have retreated back down to 6.94% since.
• According to FactSet, 96% of the S&P 500 has reported Q4 results as of last Friday, May 24th, 2024. The earnings growth rate, blended between companies that have already reported with the estimates for those that have yet to report, is at 6.0% year-over-year, which is above analyst expectations of 3.4% going into this earnings season. If the blended rate of 6% comes to fruition, it would mark the highest year-over-year earnings growth rate for the S&P 500 since Q1 of 2022.

Hot Reads

Markets

• Fed Officials Saw Longer Wait for Rate Custs After Inflation Setbacks (WSJ)
• The Fed Probably Won’t Be Delivering Any Rate Cuts This Summer (CNBC)
• CPI Report Shows Inflation Easing in April, with Consumer Prices Still Rising 3.4% from a Year Ago (CNBC)

Investing

• Lazy Work, Good Work (Morgan Housel)
• What Our Brains Know About Stocks – But Won’t Tell Us (Jason Zweig)
• Who’s to Blame for the Broken Housing Market (Ben Carlson)

• Watch Tiger Woods’ Driver Clinic With Rory McIlroy and Nelly Korda (YouTube)
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• What Does an AI DO When It Sees an Optical Illusion (ScientificAmerican)

Markets at a Glance

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Economic Calendar

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION