Gold vs. Paper Money: a rant

Have you ever seen these TV commercials:

“Governments are trillions of dollars in debt and are printing paper money at record pace. So, don’t invest your retirement in paper money. Transfer your IRA to a Gold IRA at XYZ Capital. Call now for your free IRA transfer kit.”

I have to cringe every time I see or hear that. What deceptive marketing! Our financial assets (equity ETFs and Mutual Funds mostly) are not invested in paper money, they are merely denominated in paper money. In fact, if people are so troubled by measuring their equity portfolio in USD paper money, they are free to measure it any way they want: ounces of gold, metric tons of copper, bushels of wheat, gummy bears, the choices are endless. And by the way, don’t forget that gold is denominated in paper money USD as well!

Corporations are not just a pile of paper money (though they may keep some cash on the balance sheet). Instead, they own land, structures, equipment, intellectual property, etc. and all these non-paper assets generate a steady flow of income, called corporate profits and worth trillions of dollars every year. They are paid out as dividends and/or reinvested in productive assets again. Gold is just sitting there. It doesn’t produce income, it doesn’t pay dividends and gold molecules don’t reproduce last time I checked. Hence, the Warren Buffett quote:

“Gold gets dug out of the ground […]. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Example: $1.00 invested in 1871 (not a typo, 145 years ago), should be worth this much today (in inflation adjusted dollars) if invested in…

  1. Paper money under your mattress: $0.05. Yup, inflation ate 95% of your paper money!
  2. Silver: $0.59. Not a typo, silver appreciated by less than the CPI index
  3. Gold: $3.06. Gold grew by less than 1% p.a. over inflation for a measly 206% compounded real return over 145 years.
  4. S&P500: about $11,000 with dividends reinvested. And, yes, that’s inflation-adjusted. In nominal dollars that would have been around $200,000!

So, gold and silver handily beat the paper money under the mattress (a very, very low bar, indeed) but equities left everything else in the dust thanks to generating actual income. Equities are a far superior long-term investment. These deceptive TV commercials prey on the fears of uneducated people and the fact that we keep seeing these commercials means that there must be a steady flow of victims for this nonsense.

But for the record, before we get hate mail from the gold-bugs, let’s state this:

  • Gold and silver coins are pretty to look at and have potentially great sentimental value and historical relevance. Check out the coin collector blog of J Money (the guy behind Budgets are Sexy and Rockstar Finance). If collecting coins is your hobby great for you. But don’t call it an investment and don’t waste the limited space in your IRA on gold coins.
  • Since we are responsible and frugal with our money, we are the first to admit that we are troubled by too much government spending and debt. We absolutely agree that the government should be more careful with its our money. In fact, if a presidential candidate could commit to making Mr. Money Mustache the Treasury Secretary (or some other role to cut wasteful spending), he or she would have our vote. But too much government debt is no reason to sell stocks and invest in gold coins.
  • Nominal bonds and money market accounts are paper money with pretty measly interest rates right now, so we share the concern about those forms of paper money. Hence, we are not very optimistic on bonds and like to keep the share of money market, cash holdings and emergency funds to an absolute minimum and rather invest in productive assets, such as equities.

12 thoughts on “Gold vs. Paper Money: a rant

  1. Thanks for sharing your insight and some notable stats on the value of a dollar over 145 years against other forms of exchange. Equity investments are the way to go. I guess whatever gets more heavily marketed is what gets sold to the masses.

  2. As a trained chemist, I loved the quote:
    “Gold molecules don’t reproduce last time I checked”

    Glad I am like those Martians and scratching my head.

  3. Nice article and fully agree with what you say.
    There might just be 1 aspect you overlook, and that is the opportunity that comes with gold and silver after a period of “all is cool and safe” towards a more uncertain period. At these times, there is an opportunity… Agreed, it does require some timing and some luck to have the timing right. Or a lot of patience to sit it out when your timing is a year off. And yes, the same can be said with timing stocks. That is why I do all of this with my play money…
    I bought my first gold a year too soon… And with hindsight, most of this is luck. I just understand much better now what goes on with gold and silver and hope to be better at it with the next cycle…

    1. Thanks! Good point. There is that safe haven property of gold and negative correlation with stocks during crazy periods.
      I could be convinced to buy gold futures contracts. That’s on margin and doesn’t eat up the space in the portfolio, so no opportunity cost of selling equities or other productive assets. That would be one way of getting around the low expected return and the high transaction costs of physical gold.
      Something to think about. hmmmm…

      1. That negative correlation is what drives me for now… Futures trading should get some more attention from me. I am jus “scared” from the big amounts at risk. A future contract is just too big for my portfolio.

        1. There is an E-micro contract on the CME (10 ounces):

          Obviously it’s not quite as liquid as the big one (100 ounces).
          But the trading costs will be lower than for physical gold coins and one can do it on margin without having the opportunity cost of having to sell stocks. Also, a few gold coins in a portfolio don’t really make that much of a difference. To have in impact, 10 ounces (~$13,300) would be the absolute minimum to have any effect.
          In the U.S., there is also the preferential tax treatment: capital gains on physical gold is taxed at the high tax rates for collectibles (28%), while metals are taxed as Section 1256 contracts (considered 60% long-term gains, 40% short-term hgains).

  4. To see if my current understanding of futures is correct.

    Suppose I buy this future of 10 ounces of gold. It blocks 600USD margin. Then gold drops with 10USD/ounce. As such, I need to add 10*10USD to my margin account. Correct?

    1. Correct. But I would never recommend holding only those $600 in the account.
      Right now we’re holding a large amount in bond mutual funds (Muni bonds with tax free interest) and trade the equity exposure through futures. Short puts on equity futures to be precise, I emailed you about that before, 🙂
      The nice thing is that the margin on the short puts doesn’t even have to be held in pure cash. 75% of the value of the bond fund counts towards your margin. That’s an amount multiple times the minimum maintenance margin for us.
      So that’s the advantage of having a futures trading account holding not just your futures investments but also a sizable share of your total portfolio: margin constraints never bind.

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