Solid Gold in the '70s

The worst investment ever
In his classic text, Stocks for the Long Run, Jeremy Siegel points out that over the past 200 years, gold has been just about the worst-performing asset class. The real, inflation-adjusted, return on gold from 1800 to 2001 was essentially 0%, compared to 6.9% for stocks. Over 200 years, that's the difference between a modest investment stagnating or growing into dynastic wealth. The Fool routinely recommends that investors focus on the stock market to build wealth over the long haul due to the superior returns from America's greatest companies.

However, I don't think we should use this data to toss gold into the trash bin of history just yet. For the first 150 years of the data set, dollars were backed by gold, and neither gold nor the dollar lost purchasing power. Since 1945, with the abandonment of the gold standard, the modern world has experienced chronic inflation. In this environment, gold has maintained its purchasing power, and the dollar has lost about 90% of its value. Therefore, at a minimum, gold maintains its value.

That 70s Show
Furthermore, gold has only had a true market price in the U.S. for the 35 years after the gold standard was officially dropped. During the inflation, oil shocks, and political turmoil of the 70s, gold soared. Using Professor Siegel's work, let's take a look at the difference between gold and stocks from 1966 to 1981:

Gold

Stocks

Real Return 1966-1981

8.8%

(0.4%)

Value of Portfolio 1966

$10,000

$10,000

Value of Portfolio 1981*

$34,400

$9,416

*Value in 1981 shows real value of portfolio in 1966 dollars, since returns are adjusted for inflation.

Granted, some of gold's extraordinary performance during this period was due to starting from an artificially low value. Plus, after prices spiked up to $850 in January of 1980, the party was over for the next 20 years. In that time, gold fell all the way back to $250 an ounce.

Feeling disco
Even though everyone isn't disco-dancing in bell-bottomed polyester pants, John Travolta is still around, and this decade is looking an awful lot like the 70s. Oil shocks, resurgent inflation, and global uncertainties have returned. The price of gold is soaring again. Using the CPI (consumer price index), I've estimated inflation to be roughly 2.3% from January 2000 through the present. Using this number, we can see how gold has stacked up against the stock market this decade:

Gold

S&P 500

January 2000

$281/ounce

1400

June 2006

$580/ounce

1246

Real Annual Return

9.5%

(4%)

There's no doubt that the gold and precious-metals markets are hot. To feed the buying demand, additional products have hit the ETF market. iSharesCOMEX Silver (AMEX: SLV  ) allows investors to invest in silver bullion prices. Market Vectors Gold Miners ETF (AMEX: GDX  ) allows investors to buy a bucket of gold-mining companies -- essentially similar to a mutual fund.

Bringing it on home
The big question remains whether or not this trend will continue. Gold has fallen about 20% from recent highs, because of the tough talk about inflation coming from the Federal Reserve. Is this a buying opportunity during a bull market, or the end of a brief respite from slumber? If inflation stays in check, gold will probably return to its slumber, but I'm more inclined to believe this is a buying opportunity.

I don't think inflation will go away as easily as some people think. So I'm hanging on to my gold ETFs: iShares COMEX Gold (AMEX:IAU) and Streettracks Gold (NYSE:GLD). Commodity prices have increased almost across the board. These prices have worked into the cost side of most businesses, and they're now being passed down the value chain. Eventually, high commodity prices will work their way into the CPI. The CPI also uses rents, not sale prices, to calculate housing costs -- the largest component of the CPI. In other words, during the housing-price boom of the past eight years, the housing component of the CPI barely budged. Now that thousands of apartments have been converted to condos, and buying a house no longer looks like a sure road to riches, rents are finally rising, and so is the housing component of the CPI. Because the CPI is used broadly to determine wages, benefits, and payments to retirees, I think that inflation might persist for quite some time. And who knows? Maybe those polyester leisure suits will come back, too.

Further far-out Foolishness, baby:

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Fool contributor Robert Aronen loves ABBA and owns shares of iShares COMEX Gold and Streettracks Gold. Please feel free to share your comments with him at robertaronen@yahoo.com. The Fool has a disclosure policy.


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