Is Gold Today's Safest Investment?

Americans believe gold is a better long-term bet than stocks, bonds, or real estate. Do they have a point?

It appears Ron Paul fans aren't the only gold bugs roaming around out there.

For the second straight year, an annual Gallup poll has found that a plurality of Americans believe gold is the single best* long term investment option. Better than savings accounts. Better than real estate. Better than stocks. A full 28 percent of adults ranked gold as their top choice, down from 34 percent last year, a drop just outside the five point margin of error. It was most popular among older Americans, those without a college a degree, and individuals who earned between $30,000 and $75,000 a year.

Unfortunately, Gallup doesn't ask its survey participants why they have such faith in gold, so we can only speculate about their reasons. Maybe Glenn Beck really did convince a vast swath of the country to stock up on bullion to prepare for the dollar's impending collapse. Maybe, after years of economic turbulence, gold just sounds safe. But forget the thinking. Is there a chance the country's collective intuition is right?
First, a stipulation: These days, there is no safest asset, other than -- maybe -- an inflation protected Treasury bond. So in a sense, there is no right answer to this question. But we can look at Gold's past performance, and the factors that might influence its future returns, to see if it's at least a reasonable answer.
For the past thirty years, whether you made any money investing on gold has depended greatly on when you decided to buy it. In that respect, it's been like any other asset. The graph below charts the price per ounce in dollars since 1970. Currently, Gold is selling at $1,649 per ounce, down from a nominal peak of $1,895 last September. And as Bloomberg pointed out back in 2009, people who invested in gold at it's last peak, in 1980, would have gotten a better return on an interest-bearing checking account. But if you bought gold at the low, low price of $277 in 2000, you've done fabulously, earning a 495 percent return. If you'd parked your money in an S&P 500 Index fund, you'd just about have broken even.
So fine. Gold's price rises and falls. But why? Gold's fervent devotees like to think of it as a hedge against inflation. They believe that when the government starts the printing presses, and the dollar starts losing value, investors will fly to what's tried and true. And indeed, when the greenback depreciates, gold's dollar value does rise. But so does the price of any commodity traded on an international market. Buying wheat or copper would offer the same benefit. Others consider gold a safe haven asset, meaning that when the markets are in turmoil, gold is the option of last resort. The problem with this approach is that the dollar is also considered a safe haven asset. That's why, even as our markets seemed to be collapsing during the financial crisis, its worth jumped. So problems in the world economy, or even the U.S. economy, can also bring down the price of bullion.
Around the time gold was peaking last year, New York Times columnist Paul Krugman offered up another interpretation of its price swings. Although he'd probably bristle at this, his theory is a variation on the safe haven school of thought. Here's the one-sentence version: When nothing else is going to pay much, people buy gold. Gold is only valuable to investors when a) they believe it's going to rise and b) when the return offered by other investments will be lower. When interest rates are high, the appeal of gold is relatively low. When interest rates drop, and the returns on assets like treasury bonds shrink, gold turns into a better option. Over the past decade, real interest rates -- the federal funds rate minus inflation -- have been fairly low. Today, yields on 10-year Treasuries are actually negative. All this means investors don't have much to lose, and possibly a lot to gain, by piling into gold -- especially if they think other speculators will stampede towards it because of inflation fears.
There's another factor that we Americans tend to forget about: the rest of the world. Gold, after all, is actually used to make things, namely jewelry and electronics. According to the World Gold Council, and industry trade group, about two-thirds of the consumer market for gold, including jewelry, is in East Asia, India, and the Middle East. Those countries also have growing investor classes. As they've gotten wealthier, their desire for gold has spiked. The chart below shows the dramatic increase in demand from China and India since 2009:
So are all those gold bugs right are wrong? Again, it's hard to say. Interest rates. Global growth. The performance of other assets. The expectations of frighty investors. All of these factors play into the price of gold, and they're hard to predict. Right now, gold appears to be past its peak. But if you believe U.S. interest rates are going to stay low as the economy stumbles along, and that Asia's markets are going to keep growing, the shiny stuff might not be a bad long term investment. On the other hand, if you believe that the U.S. economy will heal in the next couple years, causing interest rates to rise, then perhaps your money is better off elsewhere. So the question really boils down to this: Will we be better off in ten years than we are today?
*An earlier version of this article misstated the question as "safest" long term investment. Mea culpa.