The gold bugs have certainly been gloating of late (well, excluding the prior 2 trading sessions) seeing as how bullion prices, miners and precious metals ETFs have been holding up well while most other asset classes spiral downward in a volatility vortex. In the short term, sure, gold has performed well and may well continue for some time to come. However, on a long-term basis, there’s no reason to believe gold, and especially, the most popular gold proxy ETF (GLD) will outperform other conventional asset classes, and in fact, it should probably be expected to actually underperform. Here’s why.
1) You Don’t Even Know WHY You’re Buying Gold – This is sadly true of most retail investors buying gold coins, gold ETFs and more. Sure, it’s the water-cooler conversation of the day and it’s “cool” to be anti-establishment and agree that the entire financial system is screwed, so gold is the only true currency. And while that all sounds compelling, it’s just platitudes. Seriously, we’ve known the system is screwed up for decades and it always will be. And during some of those recent durations, gold lost double digits in no time flat while stocks flourished. That’s not to say you shouldn’t own any gold and that it may not perform well, but do you understand why you’re actually buying it and what prior price history suggests it may do in the future?
2) Markets Are Efficient and You’re NOT – While there are some anecdotal accounts of investors being able to exploit gaps in market efficiency, the reality is that for the most part, especially for retail investors like you and I, markets are efficient. Any future price spikes you anticipate due to currency, economic or inflationary events are already intrinsically reflected in the spot price for gold. The only way gold meaningfully outperforms other asset classes from here is if you know something everyone else doesn’t (or if you’re even more pessimistic than a VERY pessimistic bunch). I love when analysts say, “Gold will be at $2,000 an ounce by year-end”. Well, then why isn’t it trading at $1998/oz now?
3) No Cash Flows – While the recency effect has brainwashed young and enthusiastic retail investors, the reality is that over long periods of time, an asset with no cashflows is simply not expected to outperform stocks, even in an inflationary environment. Think about it. Gold does not pay a dividend, it doesn’t buy back shares and it can’t be acquired by a large competitor. The only thing gold has going for it is its scarcity which is already reflected in its price. There are no recurring cashflows delivered to the investor over time like a stock, a bond, or other higher yielding hybrid investments like preferreds.
4) Bubble – Glenn Beck. That’s all I have to say. But seriously, you can’t listen to CNBC on TV, the radio, or Fox News or any conservative/money programming without being constantly bombarded by gold commercials. And the claims are getting to be more an more outrageous. A guy with a raspy voice and a scary music overlay touting: “Convert your IRA to gold”…” The only asset class that has held up”… “Your 401(k) has turned into a 201(k). It’s ridiculous. And people are listening. GLD recently surpassed SPY as the largest ETF in the world by assets. By calling gold a bubble, it does not imply I’m calling a top, simply that this will end badly at some point.
5) Taxes You Didn’t Consider – Thousands of retail (and professional) investors are unknowingly buying into GLD without the knowledge that they will be taxed at a much higher rate than the long-term capital gains rate. That’s because the straight bullion gold tax rate is aligned with the “collectibles” tax rate with GLD being subject to that higher rate whereas miners and diversified precious metals ETFs aren’t. If you’ve gotta own gold in some fashion, you may well be better off in other gold-related ETFs where there’s actually a lower tax rate and cash flows to boot.
Disclosure: Ironically, the author does have a small long position in GLD for some time now and is avoiding a sale due to the high tax rate on capital gains cited herein.