Losing its Luster

The Gold Market May Have Reached its Peak

Matthew D. Pappas

August 9, 2013

Gold has been on a tear over the past few years, with investors piling into the metal as it posted a total return of more than 150 percent from the end of 2008 through 2011. But recently its trajectory has shifted and the metal is now down roughly 14 percent just this year. Compare that to the booming equity markets, with the S&P 500 up 12 percent and the Dow Jones Industrial Average up 13 percent year to date.

The data and trends show that gold and other precious metals may be in a longer-term downtrend based on our team’s analysis, which could have a positive impact on other investment opportunities going forward.

Not-so-safe Haven

Gold had a great few years as investors sought a safe haven after the financial crisis in 2008 and a hedge against potential hyper-inflation. What’s interesting, however, is that for 15 of the last 20 years, gold lagged inflation and only recently surpassed it during the Great Recession (see the chart).

If gold has lagged inflation for so long, why the sudden spike? The reason is fear. You certainly can’t argue that gold prices shot up during the recession from higher industrial demand.

Look at the chart and consider the S&P 500 over the past 20 years—which would you rather own as an inflation hedge? This chart doesn’t even calculate the dividend earnings that you would have received by holding those stocks over the past 20 years. Besides, where is the huge spike in inflation that everyone is worried about? When you look at wage inflation, price inflation or the velocity of new money being created in the economy, none suggest that we are in a hyper-inflationary environment.

The more extreme reasoning for hoarding gold is fear of the global economic system collapsing or even the world coming to an end. Look, things were bad in 2008 and, admittedly, our financial system nearly collapsed from the combination of many different factors. Since then, however, companies have rebounded dramatically, consumers are paying off their debts and the economy is pushing forward.

Whether you hate President Barack Obama or think the Tea Party is crazy doesn’t matter—each side has its reasons why the other is leading our country toward destruction. But antics are just that. The facts are what illustrate the direction that we’re heading in:

•U.S. household net worth is up $13 trillion from the low in 2008 and up $5.4 trillion from 2012. The total per-capita net worth level is now only 6.5 percent below record levels and the housing market (which makes up a large percentage of net-worth) has not yet fully recovered.

•The Congressional Budget Office predicts the budget deficit will hit 5.3 percent this year and level out at a sustainable 3 percent over the following 10 years, all else considered.

•Existing home sales nationwide are up 9.1 percent through March 2013, with new home sales up 18.5 percent and housing starts up 46.7 percent.

•Expansion in U.S. oil and gas exploration is predicted to allow the U.S. to be energy independent by 2020.

These are merely a few examples of the vast economic improvements that are happening right now. Given these trends, I simply do not see the case for gold as an investment going forward, particularly in lieu of equities. The opportunity cost of holding gold versus equities will only increase if the economy grows, even at this slow pace.

Case in point, wouldn’t you rather own something that you can actually value with more accuracy? Public companies publish all of their financial information including cash flows, dividend yield, growth projections, et cetera—all of which are used to calculate that company’s share price. Gold is a different story. How do you calculate its fundamental value when emotion plays such a big role in its price? Sure, you can analyze sentiment levels and supply and demand, but gold doesn’t have a balance sheet. Besides, investor sentiment levels are still relatively low today but the stock market is performing very well. Why? Because equities always revert back to their fundamentals—it’s a trend that has been proven historically. While we have periods of emotional spikes one direction or the other, in the long run prices revert back to their economic and corporate fundamentals.

Many don’t realize this, but even though gold had a 150 percent run from the end of 2008 through 2011, equities have posted even greater percentage gains since their bottoming in March 2009.

I believe that the bull run for gold is coming to an end. While you may still not believe in this recovery, the numbers don’t lie. The economy is improving in terms of employment, manufacturing, home prices, corporate balance sheets and even the federal budget deficit. Equity valuations still look attractive broadly speaking, financing is cheap and even the antics in Washington are not having the same effect that they did a year ago. The focus is reverting back to the fundamentals, which should favor equities.

Unfortunately for those investors holding large quantities of gold and other precious metals like silver, the ride is over.   

Matthew D. Pappas is a financial adviser with the Cottonwood Group of Wells Fargo Advisors, LLC, a wealth management team based in Salt Lake City.



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