American Gold Eagle

Image via Wikipedia

For the last two years, the media has added to their “daily scores” the value of gold, which is now referred as often as the latest movement of the S&P 500 or the “Dow”. But today I’ll focus on gold.

Is gold really an inflation hedge?

A lot of pundits refer to gold as an “inflation hedge”, but is it? It is not. Since 1971 (when the gold standard ended in the U.S. and prices were freed to reflect the effect of supply and demand) and until the end of October, 2010, gold’s total return is barely superior to that of U.S. long term government bonds.

So, what to say about the rise in prices for the last six years?  Yes, the last six years gold has risen in value, but that doesn’t mean it will keep doing it. If you believe that gold prices will continue to rise because they rose in the past, you’re applying the fallacy of extrapolation, just like believing that home prices would “never” go down.

Where is the price of gold going?

Nobody knows what the price of gold will be tomorrow, but the last few years have reminded me about the .com bubble and about the tulipmania in the XVII century.

What about the fears that the world is coming to an end?

Some pundits argue that gold is rising because of an imminent crisis that will damage the economic system at large.

But, think about it for a second.

Imagine that you wake up one day and the economic system is severely damaged. If that was the case, there would probably be riots in supermarkets and people fighting over food. What are you going to do with your gold in such an event? Will it be worth anything? Even worse, what if your gold was represented through ETF shares? What will you do? Will you say something like: “here’s my latest statement from e-trade, as you can see, I have a lot of gold, can I exchange it for a box of Twinkies?”. I would rather keep my box of Twinkies than trade it for your worthless account statement.

So, what to do?

I am an optimist. I believe that people look for their benefit by benefiting others. That is the key principle of Capitalism. Hard work, determination, creativity and innovation have taken us out of depressions, wars and previous crisis. I believe that this time won’t be different and that the world will keep getting a better place for everybody that works to do it.

So, save your worries about gold and enjoy your life. If you’re an investor, just make sure that your portfolio is properly diversified using low-cost index funds. And turn off CNBC.