To boot, gold purchases by central banks have long been cited as a bullish catalyst. But now fears are swirling that the central bank of Cyprus will be forced to dump its gold to finance an international bailout. If Cyprus, who else? Portugal? Spain? Italy?
The irony is that the goldbugs may get the story right but the investment wrong. Like any asset, gold is forward-looking and prone to wild overreactions. So prices doesn’t always mesh with what’s going on in the economy. Inflation in the 1980s averaged nearly 6% — triple current levels — and gold lost more than half its nominal value. It is entirely possible that the coming years will bring high inflation, but tumbling gold prices. Just as the Internet blossomed while the Nasdaq plunged from its high in 2000, asset prices can gallop far away from the stories people buy into them for. Indeed, they usually do.
Historically, gold has surprisingly little correlation with inflation. As one Citigroup research report put it: “There is no obvious relationship between the gold price and inflation.” Instead, gold correlates fairly well with two events: negative real interest rates and financial panic. But if the economy is healing, as many think it is, real interest rates are likely to rise. And as the Cyprus bailout showed last month, markets appear to be well past the panic stages of the financial crisis. One interpretation is gold’s fall is the shift in how investors perceive risk — away from a world obsessed with panic and collapse toward one focused on long-term growth.
For those in gold for the long haul, that should be unsettling. Over time, gold’s real return averages close to zero:
| Asset | Average Annual Real Returns, 1838-2012 |
|---|---|
| Stocks | 6.49% |
| Treasury bonds | 2.77% |
| Gold | 0.46% |
Source: Deutsche Bank Long-Term Asset Return Study
The stock market falling 20% or more is typically nothing for long-term investors to fret about — historically, it’s a once-every-five-years occurrence, with large gains over time. Gold is different. Over the long haul, the best it will do is preserve wealth. In between, it goes through periods, sometimes decades-long, of boom and bust.
No one knows if the gold story has peaked. What we know is that it’s riskier than many believed. As Bill Bonner says, “People do not get what they want or what they expect from the markets; they get what they deserve.”
The article Gold Collapse: The Start of Something Big? originally appeared on Fool.com.
Motley Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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