By Kishori Krishnan Why

Spanish philosopher George Santayana had warned: “Those who cannot remember the past are condemned to repeat it.” The same could hold true for gold.

The interest in the yellow metal is based on the fact that the price of gold has risen more than $700 since 2002. Consider a few points first: In January 1980, the price of gold hit $850, an increase of over $700 from its price just five years earlier. At that time, analysts shrieked to all and sundry about the fears of inflation, a falling dollar, huge budget deficits and foreign policy problems.

Sounds familiar? Cut to June 1982: the price of gold had fallen to less than $300 an ounce. And more than 20 years later, in January 2002, it was still trading at less than $300.

So, what is behind the recent hype? Last week, the price of gold breached the $1 000 per ounce level, a height it last reached at the peak of the global financial crisis in 2008, before falling back down to the upper $900s range.

Generally, when the gold price rises and tips past crucial levels, it lets us know that people are worried about inflation. Gold is generally seen as a safe haven asset, which means that when people are worried that governments are printing too much paper money, they tend to buy gold as a way to “store value”.

The printing of paper currencies, which has no real upper limit, tends to push up the price of gold, which is finite - it’s the old story of more money chasing a limited amount of goods.

Considering the events of the last 18 months, during which governments around the world have aggressive spending programmes in a bid to rescue the world economy, many of these spending plans have essentially been funded by printing new cash. Which only goes to prove that there is a heck of lot more paper money in circulation today.

Another bogey is the global currency fluctuation. Though for eight years it has produced double-digit rates of appreciation against nine of the world’s major currencies - USD 16.3 per cent, AUD 13.3 per cent, CAD 13.6 per cent, CNY 13.5 per cent, EUR 10.8 per cent, INR 16.8 per cent, JPY 13.6 per cent, CHF 10.6 per cent and GBP 17.1 per cent - when one compares it to crude oil prices in terms of four different currencies - US dollars, British pounds, euros and goldgrams - it is very different story.

Tracking the crude oil prices from January 1950 through March 2009, the price of crude oil in terms of gold has basically remained unchanged over the 59-year period.

In other words, a gram or ounce of gold today buys essentially the same amount of crude oil it did in January 1950. Clearly, this would make gold a lousy investment, for there has been no appreciation from owning gold. One can buy the same amount of crude oil with gold that you could in 1950, not more.
In other words, a so-called ‘investment’ in gold has generated zero return.

Gold might have achieved double-digit rates of appreciation this decade against the world’s major currencies, but still buys an unchanged amount of crude oil. Does that not make you stop and think?

Gold is not really appreciating. Instead, the US dollar and eight other currencies mentioned above are depreciating. They are losing purchasing power.

Moreover, one doesn’t drive a car based on what you see in the rear view mirror. Neither is investing based on yesterday’s returns. This has led many investors to buy yesterday’s winners high and sell yesterday’s losers low. And buying high and selling low is not exactly a prescription for investment success.

Over the very long term, gold has provided virtually no real return. However, the attraction of gold is not a high expected real return, but that it has had a negative correlation to equities - it has a tendency to do well when stocks are doing poorly.

Sure, gold does hedge some (but not all) of the risks of equity investing. It can be a haven in times of crisis when investors are seeking safety. However, you only get the benefit of negative correlation if you have the discipline to rebalance. And that can be a very tough task.

Gold’s ongoing struggle to decisively establish itself above $1,000 an ounce has generated thousands upon thousands of words in debates.

Gold does hedge some of the economic and political risks that equity and bond investors face. But the only way investors have been rewarded for doing so is that they have had to show the patience and discipline to wait 20 or 30 years and then get the benefit - and that means rebalancing along the way, buying AFTER if goes down and selling AFTER it has gone up. Otherwise the returns have been miserable.

Recognize the risks, recognize that they tend to go for very long periods of very poor returns with short and unpredictable bursts of great returns, and be prepared to buy low and sell high, despite what the noise of the market and your own stomach must be telling you to do.

So, are you ready for the long haul?