Guest Post: Is Gold A Reasonable Investment?

By George Washington of Washington’s Blog.

(Rest assured that once Yves is done writing her book, and back posting,  or other guest posters write more, I will post less often! )

This essay rounds up arguments for gold as a reasonable investment.


Commentators such as Ambrose Evans-Pritchard and Byron King argue that China’s hunger for gold will put a floor on gold prices.

Specifically, they argue that China will “buy the dips” in gold prices, effectively putting a minimum on how low gold prices can go.


It is conventional wisdom that gold is a hedge against inflation.

For example, noted inflationist John Williams advises buying gold.

Axel Merk argues that gold is a better buy than TIPS as an inflation bet.

And Taleb advised buying gold in May, since currencies including the dollar and euro face pressures.


If gold does well during times of inflation, it makes sense that it would perform poorly during deflationary periods.

But points out that such an assumption is probably untrue.

Specifically, as writes:

Eric Sprott – who manages $4.5 billion in assets, and correctly predicted in March of 2008 a “systemic financial meltdown” – says:

“I believe no matter what environment you’re in – deflation or inflation – people will run to gold,” Sprott said. “Gold is proving exactly what we all would have expected, that in almost any environment, it’s a go-to asset.”

And investment analyst and financial writer Yves Smith argues that gold does well during both periods of deflation and high inflation. She argues:

Historically, gold does well [in] hyperinflation and deflationary [periods]. Gold does poorly under more normal conditions, and gets hammered in disinflationary conditions, a falling but positive rate of inflation.

Analyst Adrian Ash argues that gold’s value actually increases during periods of deflation even if its price drops:

Does the price of gold rise or fall in a deflation?Hint: It’s a trick question, already tripping up plenty of would-be advisors…

Absent the money-supply limits which the gold standard imposed on the world, people rightly guess that double-digit inflation would prove rocket-fuel for the bull market in gold. Yet the purchasing power of gold nearly doubled during the Great Depression, and it’s risen four-fold during this decade’s low consumer-price inflation as well.Why? Because both those periods of low price-inflation saw the money-issuing authorities devalue the currency, first with explicit reference to gold but now without daring to name it. Roosevelt in the mid-30s slashed the dollar’s gold content by 40%; the Greenspan/Bernanke Fed devalued the Dollar again to sidestep a DotCom Depression, keeping real interest rates at less than zero, between 2002-2005.

The maestro’s apprentice applied the same trick in the back-half of 2008, but so far to no avail. And now even the European Central Bank is pumping out money – a near half-trillion euros today alone – in a bid to revive bank lending, swamp the currency markets, and pull Germany out of its first flirt with deflation since the 1930s.

Just such a devaluation – and again, absent any stated reference to gold – was attempted by the Bank of Japan a little less than a decade ago.

Indeed, Japan is the only developed nation since the end of the gold standard to have suffered an extended deflation in prices. So far, at least. Germany and Switzerland look set to try for a re-wind, and unless the dollar can outpace the euro’s descent, we might yet see truly sub-zero inflation in the United States, too.

But whatever that should mean for gold prices, all other things being equal, just doesn’t matter. Because the gold price will not get a chance. All other things are not equal, and the policy solution – rank devaluation – can only make gold more appealing to investors and savers, whether the “monetarist experiment” of TARP, quantitative easing or a half-trillion euros proves successful or not.

Japan’s slump into deflation coincided with the Bank of Japan’s “zero interest rate policy” (ZIRP) at the start of this decade. It also saw the gold price worldwide hit rock-bottom and turn higher, a move that analysts (including us) have typically linked to US monetary moves and investment cash looking for safety as the Dotcom Bubble exploded.

But zero-rate money from the world’s second-largest economy shouldn’t be ignored. And today, zero-rate money is all the developed world has to offer – a trick that might not beat deflation, but might just spur a whole new rush into gold.

In other words, Ash argues that you can’t take inflation or deflation in a vacuum. During deflationary periods – like we have now – governments always increase the money supply with a flood of new dollars, which is bullish for gold.

And PhD economist Marc Faber wrote in October 2007 that gold will do well even in a deflation:

How would gold perform in a deflationary global recession? Initially gold could come under some pressure as well but once the realization sinks in how messy deflation would be for over-indebted countries and households, its price would likely soar.

Therefore, under both scenarios – stagflation or deflationary recession – gold, gold equities and other precious metals should continue to perform better than financial assets.

Looking At the Charts

Is Faber right?

Well, take a look at the following charts showing gold’s performance as compared to the yen during Japan’s “lost decade” of deflation:

Japan’s deflation didn’t definitively end until 2007 or 2008.

This provides some evidence that gold may tend to hold or increase its value at least in the later part of the deflationary period as compared with the relevant national currency.

Moreover – approximately half the time – gold has risen during recessions in the United States:

(The grey vertical bars show periods of recession; the chart gives gold prices in monthly averages; click here for larger image).

If you study the above chart, you will see that gold seems to often fall during the beginning stages of a recession, then rise in the later stages of the recession (before 1971, the dollar was still backed by gold at a fixed price, and so gold did not fluctuate).

But what about Ash’s theory?

The American Enterprises Institute notes:

After five years in a deflationary economic wilderness, the Bank of Japan switched during the spring of 2001 to a policy of quantitative easing–targeting the growth of the money supply instead of nominal interest rates–in order to engineer a rebound in demand growth.

Look again at the first gold chart for Japan, above. Gold appears to start increasing against the Yen in 2001.

This may provide some evidence for Ash’s thesis that it is an expansion of the money supply which pushes the price of gold up in the later stages of deflationary periods.


Finally, Chris Martenson argues that – in prolonged periods of deflation – we usually see failures of large and significant banks, institutions, and perhaps even states and countries. Because gold traditionally does well during periods of uncertainty, Martenson likes gold during periods of deflation. notes in a subsequent article:

Merrill Lynch agrees.

Specifically, PhD economist Nouriel Roubini paraphrases a report from Merill Lynch (not available online) as follows:

Short-term rates of 0% are bullish for gold, which serves as a store of value but is a useful hedge against deflation as well, since deflation is inherently destabilizing for financial assets. In the 2001-03 deflationary period, gold rose more than 30%, not to mention the prospect of a return to a dollar bear market. “Gold is inversely correlated to global short-term interest rates and there is a race right now towards 0%. Production is down 4.0% y/y while fiat currencies globally are being created at a double digit rate by the world’s central banks….As for all the talk of a ‘gold bubble,’ it would take a nearly 625% surge in gold to over US$6,000/oz and a flat stock market to actually get the ratio of the two asset classes back to where it was three decades ago when bullion was in an unsustainable bubble phase.”

Gold tends to be less sensitive to global economic slowdown than industrial metals or energy and works better as a hedge against crisis than inflation.

Global Short Term Interest Rates Are Low

The above-quoted Merrill article states:

Gold is inversely correlated to global short-term interest rates and there is a race right now towards 0%.

This argues for gold.

Polls Show Distrust in Government

Time Magazine writes:

Traditionally, gold has been a store of value when citizens do not trust their government politically or economically.

Given the enormous levels of distrust in the government politically and/or economically (and the fact that some have warned of recession-induced violence), gold might do well.

Greenspan and Exeter

Professor Emeritus of Mathematics Antal Fekete has argued for years that gold is the ultimate – and only – safe haven when things really hit the fan.

For example, in 2007 Fekete wrote:

The grand old man of the New York Federal Reserve bank’s gold department, the last Mohican, John Exter explained the devolution of money (not his term) using the model of an inverted pyramid, delicately balanced on its apex at the bottom consisting of pure gold. The pyramid has many other layers of asset classes graded according to safety, from the safest and least prolific at bottom to the least safe and most prolific asset layer, electronic dollar credits on top. (When Exter developed his model, electronic dollars had not yet existed; he talked about FR deposits.) In between you find, in decreasing order of safety, as you pass from the lower to the higher layer: silver, FR notes, T-bills, T-bonds, agency paper, other loans and liabilities denominated in dollars. In times of financial crisis people scramble downwards in the pyramid trying to get to the next and nearest safer and less prolific layer underneath. But down there the pyramid gets narrower. There is not enough of the safer and less prolific kind of assets to accommodate all who want to “devolve”. Devolution is also called “flight to

Darryl Schoon makes the same argument.

Here’s a visual depiction Exeter’s inverted pyramid, courtesy of FOFOA:

(Click here for full image; I am not certain every level of the pyramid is accurately ranked)

Alan Greenspan has just lent some support to the theory. Specifically:

Gold prices that jumped above $1,000 an ounce this week are signaling that investors are buying metals to hedge against declines in currencies, former Federal Reserve Chairman Alan Greenspan said.

The gains are “strictly a monetary phenomenon,” Greenspan said today at an investment conference in New York. Rising prices of precious metals and other commodities are “an indication of a very early stage of an endeavor to move away from paper currencies,” he said…

“What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,” Greenspan said.

In other words, Greenspan is saying that investors are moving out of the second-to-lowest step on the pyramid (currencies and government bonds) and into the lowest step (gold).

Greenspan is also verifying what goldbugs like Exeter, Fekete and Schoon have been claiming: that “the barbarous relic” still holds an important place in the modern investor’s psyche.

Are Exeter, Fekete and Schoon right? I don’t know. And Greenspan might be wrong, or trying to excuse weakness in the dollar (as opposed to all paper currencies).

Note 1: Zero Hedge alleges that newly-declassified federal documents prove that gold prices have been manipulated for decades. If these documents are authentic (I have no reason to doubt their authenticity, but have no inside knowledge), if the claims of artificial price suppression are true, if this is widely publicized, if such publicity causes someone like Congressmen Alan Grayson, Brad Sherman, Ron Paul, or Dennis Kucinich to raise a ruckus in Congress, and if Congress as a whole votes to ban such a practice, then the price of gold would presumably rise. That’s a lot of ifs.

Note 2: Some of the best recent arguments I’ve heard against gold are written by Vitaliy Katsenelson. Read this, this, this and this.

Note 3: I am not an investment advisor and this should not be taken as investment advice.

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  1. bob

    George- I appreciate your even handed, analytical reporting on these debates.

    As someone last year said- the ads I see on tv are for people buying gold, until I see more ads by people trying to sell gold I am suspicious.

    I think the ratio of seller vs buyers has improved since then.

  2. fergerst

    I feel it is somewhat misleading to assert gold will make a similar run as it did in 1980s. First off, we abolished the gold standard and that was causing some confusion and great deal of fear as to what its ultimate value was. Speculative fervor catapulted with 10 to 1 leverage it’s easy to see how a bubble of that nature can form. Second we have this ETF and it’s called GLD which is consuming gold at alarming rates. Somehow its supply does not sell off as rapidly as it does when GLD price declines as you would expect since they need to adjust there supply and consume shares accordingly. But instead there holding increase. This phenomenon maybe caused by naked shorting. A true 1980 style bubble will never form since selling pressure from these ETFs will moderate the rise. So as the wealthy seek insulation and security from uncertainty, here lies an efficient mechanism it rob them of there wealth in one fell swoop as people flock to it’s safety. Personally The only thing I will be looking for in gold is a great opportunity to short it, if that meteoric lunge does occur again. Checkout for more information on the impact of the gold ETF GLD.

  3. OrganicGeorge

    I’m 56 and this is only the second time, in my lifetime, that gold bugs have been somewhat correct.

    People seem to load up on gold just about the time they should exit the market.

    Can anyone here point to an example, in the latter half of the 20th century, where physical gold was used as currency and explain how it will be used as currency when the worlds financial system crumbles? Can I use a gold coin to buy food at the supermarket and what will they give me as change? And can I get a gun permit just so I can drive around with my bag of gold coins?

    I agree that Gold is a good investment, about every 25 to 30 years, just because the gold bugs will convince a new generation to push up the price when ever there is a pending disaster.

  4. Petepaul

    Can you use your stock ownership to buy bread in the supermarket? How about using the title to your house to pay for something? Or do you need to convert it to another form, Federal Reserve Notes or electronic blips on the screen, to exchange it for other goods.

    Gold is just another asset to hold, albeit one with a very long pedigree and near universal acceptance as something of value – especially in extreme times. The question is gold’s relative value to other assets going forward.

    Personally, I don’t think you can go wrong with the old banker’s saw, keep 10% in gold and pray you never need it.

  5. David Pearson

    Gold is a hedge against inflation. Period.

    In deflation, it is better to own currency than gold. Don’t trust the banks? Fine, own T-bills. They are easier to store, more liquid, etc.

    In instability and war, the same applies.

    So why do deflation and instability cause the gold price to rise? Because they raise the likely response of the monetary authorities — printing money — raises the likelihood of higher inflation down the line. That’s it.

  6. J. Andrew Simmons

    Good read, very thorough.

    On a side note from the topic…why the ranking of corporate bonds over muni bonds in the pyramid??? Since when do corporate bonds have a lower default rate than municipals? Less than six one hundredths of one percent of investment grade munis have defaulted over the past 30+ years compared to over 2% in IG corporate. This relationship is true across all credit grades. Even during the Great Depression, over 15% of municipal debt went into default yet less than 1% failed to eventually pay back their principal. This is a substantial oversight and discredits the original author’s intent.

    1. FOFOA

      Hello J. Andrew Simmons,

      You are quick to discredit intent! Actually that pyramid was made by John Exter in the 1970’s. Here is my response to your question posted on my blog:

      The Exter inverse pyramid was never meant (on this blog at least) as an investing guide. It was used to demonstrated a concept and a flow. The pyramid itself was drawn in another era, in the 1970’s.

      Here is the source of the graphic:

      Also, my post All Paper is STILL a short position on gold has more information on this pyramid.

      John Exter, a famous gold analyst almost two generations ago, was the first to suggest that gold related to paper assets in the form of a pyramid. He described the relationship of gold to paper assets as an inverse pyramid balanced on trust. Currency at one time was a gold derivative.

      Also, this link has even more information about the Exter inverse pyramid.

      And Trace Mayer has his own version of this pyramid on his site,


        1. FOFOA

          Hi George,

          I don’t know why he put it there. I assume it has something to do with his grouping formula, but I haven’t given it much thought since it was the overall concept that interested me. What was his criteria for the red group? Could it have been something other than past default rates? I really don’t know.


  7. wally

    One really tricky issue when looking at questions of inflation, deflation, etc. is that almost all examples from history (such as the price of gold in yen) are in the context of a single country moving up or down relative to the rest of the world.
    If all countries print money or do QE, it is a different situation… and one with far fewer historical precedents.

  8. Steve Roberts

    When did Muni bonds become riskier than Corporate bonds and stocks? Plus they need to stop differentiating between OTC and listed stocks. There really isn’t the difference there once was.

  9. Sivaram Velauthapillai

    Good job with the analysis George. You ran down the numerous arguments. I have one thing to add, although it isn’t directed at you and is just a general comment.

    The proper question to ask under deflation is not necessarily whether gold will outperform financial assets; instead, the proper question, I feel, is to ask whether gold will outperform cash during deflation.

    It is not surprising to see gold outperform financial assets (as Marc Faber and others have suggested) during deflation. Financial usually get killed during deflation. For examples, just look at the stock market or (non-government) bond market during 1990’s Japan, 1930’s USA, and 1920’s USA, and so on (deflationary busts were very common under the gold standard so there are numerous examples in the 1800’s as well.)

    The real question to me is whether gold will outperform cash (or government bonds of solvent states) under deflation. My opinion to that question is that gold will likely underperform cash. It comes down to the details but it remains to be seen.

    (As a side note, I don’t think the rise in Yen gold price after 2000 indicates that gold will perform well in deflation. Although I can’t be certain, I suspect the rise after 2000 had nothing to do with Japan. Instead, I suspect it was driven by the global bull market in gold. If you looked at gold in other currencies, it also rose sharply. That implies it wasn’t a Japanese deflation effect. In other words, if your country is undergoing deflation but other countries are not, then it gets complicated and gold’s behavious likely isn’t dependent on the deflation in your country.)

  10. Seal

    One of our clients grew up on a farm in Germany. Years ago he told us about what
    happened in 1921. His parents had a large mortgage on the farm. One day, at the peak of the hyperinflation, they took ten dozen eggs to market and sold them. With the proceeds they went to the bank and paid off the mortgage.
    From ,BEST OF JIM COOK, May 24, 2005, GOLD REDUX

  11. Seal

    One of our clients grew up on a farm in Germany. Years ago he told us about what
    happened in 1921. His parents had a large mortgage on the farm. One day, at the peak of the hyperinflation, they took ten dozen eggs to market and sold them. With the proceeds they went to the bank and paid off the mortgage.
    From ,BEST OF JIM COOK, May 24, 2005, GOLD REDUX
    Oops, should have said great post! Waiting on your next post!

  12. fergerst


    Yes I can give u one example. In Zimbabwe they use gold flakes to buy bread. Gold only becomes the currency under extreme circumstances. In Zimbabwe the paper is worthless the moment it is printed.

    For developed countries, iceland for instance, the currency might half in value in a day but I would imagine that is as extreme as it gets. You still use Krona to buy bread.

  13. asphaltjesus

    In the U.S. inflation/deflation is not an either/or situation.

    Domestically, there is currently a great deal of inflation across most goods/services. The exception is real estate, but even that deflation has slowed.

    Food and end-user energy costs are all flying quite high. Meanwhile the costs of imported items are falling. I don’t think it works out to ‘deflation’ for the average worker.

  14. LTG21C

    Gold’s real problem is because everyone sees it as a speculative vehicle / currency / storehouse of value.

    The universality and the inadequate supply, coupled with the volatility of demand in the face of relatively few industrial (as opposed to jewelry and wealth storage) applications mean that the price can gyrate wildly between too high and too low.

    True, in a crunch, it is precious enough that small quantities of it is sufficient to suffice to store a large amount of value — very valuable for fleeing refugees.

    However, for larger storehouses of wealth, materials that have defined industrial applications (preferably multi-industry, multi application to smooth out demand cycles, and multiple sources to limit supply cycles) are far better.

    What would that be?

    Stores of industrial metals like copper, zinc, tin, aluminum, molybdenum, etc. meet this criteria, as does many other metals like platinum, palladium, etc.

    These are far better hedges — because we know that it is unlikely that any one or two of them will have the bottom fall out of the market at any given time.

    Furthermore, they can be stored relatively easily with limited environmental requirements to prevent corrosion.

    In the case of both copper and aluminum, a common form it can be stored in is electrical wiring — which is, to any electrician, basically as liquid as currency.

  15. Doug

    Interesting about Greenspan’s comments. Also interesting in the light of his having an Exclusive advisory relationship with John Paulson’s hedge fund. Paulson is the largest shareholder in GLD and is expressly taking that position as a hedge about the potential collapse in the purchasing power of the dollar.

    Gold is in many ways just another real asset, all of which are effective hedges against the collapse of the purchasing power of the dollar. Paradoxically, one of the things that makes gold superior is its scant alternative uses. Gold rises and falls predominantly as an alternative store of value. Other industrial materials or real assets can be overwhelmed by fluctuations in macroeconomic demand.

    The other attributes of gold that recommend it over other real assets for this use are the same ones that led it to being so widely used as actual money for so long across so many cultures, immutability, divisibility, fungibility, scarcity, portability.

    And gold does well in a deflation, just by maintaining its same ratio in currency. It can be seen as an extension of the money supply rather than a commodity or other real asset whose nominal price would otherwise be expected to drop in deflation. If you have a general deflation with generally falling asset prices, but the price of gold remains constant, the purchasing power of gold is really going up. You can buy more stuff with the same amount of gold.

    1. Seal

      “What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment,” Greenspan said.
      AND ever the conspiracy theorist in me believes Sir Alan – and others – has swapped, sold, leased, and otherwise pledged out the US’s supposed gold supply. Greenspeaks comment is just the type of obtuse stuff he comes out with alluding to that. It is no accident Paulson is into GLD big time. After paying enough ‘consulting fees’ Sir Alan has warned him all the gld is not there AND many of the derivative positions dependant on it are valueless. I still say we will be in a condition in the near future where at time NO AMOUNT OF US DOLLARS wil be accepted for gold. Greenspan will go down as the worst and most destructive banker in human history.

  16. Jona

    I definitely think that gold is highly overvalued at the moment. The problem right now is that the world economy is changing rapidly, and money has changed hands (China, India, and Middle Eastern countries possess a lot of money at the moment). The dollar’s weakening over the last decade was not a good sign either.

    Will it still go up, nobody knows, but the only question is, what’s the use of gold?

  17. MG

    Excellent summary that was pretty well-balanced with numerous sources. I would have liked to see a bit more on the physical delivery phenomenon we are seeing but thanks for the post.

  18. ¡™£¢∞§

    Did The Great Depression Have A Silver Lining? Life Expectancy Increased By 6.2 Years

    ScienceDaily (Sep. 29, 2009) — The Great Depression had a silver lining: During that hard time, U.S. life expectancy actually increased by 6.2 years, according to a University of Michigan study published in the current issue of the Proceedings of the National Academy of Sciences.

  19. whosonfirst

    It’s a hedge against inflation, it’s always been a hedge against inflation and it always will be a hedge against inflation because governments can’t print gold.

    In the world of finance and economics this is as straightforward a situation as you’ll ever find. Why do people insist on trying to complicate it?

  20. Sivaram Velauthapillai

    WHOSONFIRST: “It’s a hedge against inflation, it’s always been a hedge against inflation and it always will be a hedge against inflation because governments can’t print gold.

    In the world of finance and economics this is as straightforward a situation as you’ll ever find. Why do people insist on trying to complicate it?”

    It’s actually more complicated than you suggest. If gold was an inflation hedge then explain this.

    Following modern economic theories, central banks print money close to the GDP rate (say 3% per year). This is what has happened in USA, Canada, Europe, and other countries, in the last 30 years (the printing was actually slightly larger at times and it has been radically different in the last 2 years but let’s ignore the details for a minute.) This has meant that the US$ has lost more than 50% of its purchasing power in the last 30 years (if you don’t believe this, just look at the CPI index or look at say wages or land or something.)

    So if the currency has declined so much then how come gold went nowhere for many decades (except in the last 4 or 5 years.) Perhaps gold was overvalued at its peak in 1980 but even if you ignore the peak and look at its price from, say, 1977, gold did not behave as an inflation hedge.

    Although gold is thought to be an inflation hedge, you can easily go bankrupt if you blindly bet on that…it is indeed more complicated.

  21. Shruti Rathod

    Dear All,
    It is very interesting to read all of your comments and analysis on such a vast topic that begins with gold. Reading all the above comments and articles, it is clear that all of you have deep knowledge about the subject. I am an undergraduate student form Regents Business School London, Regents College and I am writing my dissertation on Gold: It’s Significance and Value in the Society, Governments and Commerce. I would be very greatful to you if all of you could please fill in a small questionnaire I have designed as a part of my primary research and enlighten me with your knowledge. The link is:
    Click Here to take survey

    Thankyou for spending your valuable time reading this. I apologise if I have interrupted your blog.
    Shruti Rathod

  22. Amy

    I have little knowledge about purchasing Gold/precious metals. I keep hearing that the dollar will not be worth much, or should I say is not worth much at the present time. I would like to put the little money I have saved into something that will grow over the next 5 years.
    My question then is: Isn’t supply and demand the same for any investment vehicle, i.e., Real estate market went up, up, up and then it crashed…. Doesn’t an increase in demand normally decrease the value over time? Will the demand for Gold eventually lead to gold prices going down? Would it be true in this case that “what goes up must come down”?? What about other precious metals, i.e., silver, platinum?
    Your input is greatly appreciated. Please excuse my ignorance on such an important matter.

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