Gold, What Is It Good For?

Given the recent volatilty in gold, I think it’s a good time to raise the title question. Why? Because I, for one, have often wondered about the answer.  The answer may not be absolutely nothing, as in the Edwin Starr song, but it is a lot less than you might think. The yellow metal has reacted meaningfully during only two incidents in the 44 years since Nixon closed the gold window on August 15, 1971: the 1970s inflation/oil crisis and the 2000s rise of China/financial crisis/debt deflation.

At best, gold is a useful tactical asset in situations where returns on safe assets turn negative.  Those incidents have been relatively rare. Gold should not be a perennial in your portfolio if you live in a place with developed financial markets and the rule of law. It earns no income and serves little purpose.

Gold is touted as many things, particularly as a hedge for inflation and as a safe asset in fraught times. It is neither.

Gold has an inconsistent relationship with inflation. The two episodes in which gold has correlated well with changes in the CPI are stark opposites. It probably gained its reputation as an inflation hedge because it correlated highly with the inflation of the 1970s. Since the financial crisis, it has also correlated well with inflation, which has been very low.  Not my idea of an inflation hedge. Between the malaise of the 1970s and the global financial crisis gold’s correlation with inflation was volatile and largely negative.


As for gold’s crisis hedging quality, take a look at its chart from the end of Bretton Woods to today.*  There are two spikes in the gold price.  The first occurred at the end of the 1970s.  It followed the great inflation and two oil shocks and dissipated in the wake of Volcker’s tightening of monetary policy.  Spike two came with the rise of China and the run up of commodity prices in its wake. It continued into the financial crisis.  So gold could have provided a counterbalance to your portfolio during two ugly incidents in financial markets. What about the myriad other crises we have been through over the past 44 years?


What did gold do during the savings and loan crisis in the late 80s, the ERM crisis of the early 90s, the Tequila crisis of the mid-90s, the Asia crisis of the late 90s, the tech wreck of the early 2000s?  The answer is precisely nothing.

Gold has done well when safe assets, like US treasuries, offer negative real returns. It is only at such times that an asset which earns nothing and may cost you (or the ETF provider) something to store is worth holding. The final chart shows the real gold price (gold deflated by the CPI) in orange and the real US 10 year treasury rate (US 10 year minus inflation) in blue. It shows very clearly that the spikes in gold line up very well with the negative real rates of the dual oil crises of the 70s and the global financial crisis.


We seem to be at the cusp of the Fed moving away from its zero interest rate policy. Real rates are likely to become positive across the curve over the next few years. That has turned gold into just another commodity; it will remain that way for many years.  Someday, when the imbalances have added up and policy makers misjudge events, gold will once again have a moment in the sun.

* The gold price was fixed during the Bretton Woods era, from 1944 to 1971, so it could not react to any events during that time.

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