Seven Myths About Gold (Extract)

The most common arguments, myths, and points of criticism about gold
There are numerous associations, points of criticism, and arguments in relation to gold, some of
which are just plain wrong. On the following pages we want to address seven of the most commonly raised issues.

Myth # 1: Gold is (too) expensive
One might as well say that it is not the price of gold that rises, but the value of the respective paper currency that falls. Gold preserves the purchase power and in fact even increases it gradually. Comparing how many real assets one ounce of gold would buy in a historical context, can  substantiate this statement. In 1980 the American currency had a significantly higher purchase power than today.

According to the official inflation calculator of the Federal Reserve, the inflation-adjusted all-time-high of one ounce of gold is currently USD 2,300. In other words, the gold price would have to rise to USD 2,300/ounce in order to reflect the real equivalent value of 1980. Oil, the black gold, has recently passed its real highs of the 1980s for the first time – we expect a similar scenario for gold sooner or later.

oil and gold

The inflation-adjusted gold chart puts the most recent price increases into perspective. While
the gold price was at USD 850/ounce at the end of the 1970s/beginning of the 1980s, the
average American household income amounted to about USD 17,000 per year. Nowadays an annual income of USD 17,000 would put a family of four below the poverty line.

The level of debt has increased dramatically as well over the past decades. Whereas private households were USD 10bn in debt in 1987, this amount has meanwhile increased to USD 28bn, i.e. 350% of GDP. This means that a nominal comparison of the gold price over decades is of limited significance. Therefore the following graph shows the gold price on an inflation-adjusted basis:


Myth # 2: Gold is of no interest to euro investors
A myth easily thwarted by numbers and the following graph. The average performance per year
since 1971 has been:
– in USD: 10.8 %
– in EUR: 9.5 %
– in GBP: 6.5 %

Gold In EUR, USD GBP and EUR 1971 to 2009


The short-term charts also underline the positive development of the gold price in the most
important currencies. The development of a currency basket with equal weightings of US dollar, euro, Australian dollar, yuan, Swiss franc, Indian rupee, and British pound in comparison with
gold is shown in the following.

Gold Versus a basket of Currencies


There is little reason to believe that the downward trend will weaken in the foreseeable future, to this extent we of course stick to our positive evaluation of the gold price.

price gains of Gold in various currencies 2001 to 2009


Myth # 3: Gold does not pay interest
True – but it overcompensates the lack of interest payments by preserving the value and purchase power of the asset as well as through price increases. The US dollar has lost more than 95% of its purchase power since the creation of the Federal Reserve in 1913, whereas gold has increased by a factor of 50 during the same period. The decline in purchase power has been particularly pronounced since the abolishment of the gold standard: the US dollar has lost 80% of its purchase power since 1971. In order to buy the same basket of goods that one ounce of gold would buy in 1980 (for USD 850), one would have to spend USD 2,300 today. This is impressive testimony to the purchase power preservation capabilities of the yellow metal. On top of that, it does not produce any taxable income.

It also makes sense to compare that myth with growth shares that do not pay dividends, yet many times still outperform value shares. The counter-argument compared to bonds could therefore be, that only issuers with low ratings have to pay high coupons – or in other words, that gold is an issuer of the highest reputation and rating.

Myth # 4: The gold price is volatile and speculative
Both the past few months and a long-term look into historic time series show that gold is substantially less volatile than equities (e.g. MSCI World). Only the shares of junior explorers with low market capitalisation deserve the label “highly speculative”. In the past ten years, the volatility of the Dow Jones index has been 16%, whereas that of gold has been 12%. The correlation of gold and the S&P 500 index has been -0.15 since 1990, as confirmed by a study of the World Gold Council3. The volatility of gold has been substantially lower than that of oil, other precious metals, the GSCI commodities index, and most equity indices in the past 20 years.

According to a study by Lawrence und Colin4, gold has zero, or an even negative, correlation to all other asset classes. Over the past ten years this correlation has amounted to a mere 0.049%. Average (60-days) volatility has been at 17 since 1999, whereas equities (S&P 500) have shown an average volatility of 19.4. Also, there is no statistically significant correlation with macroeconomic data such as industrial production or GDP. 

Volatility of Gold versus the S&P500 from 2000 to 2009


Myth # 5: In periods of deflation, gold is a bad investment
The fact that gold is an excellent hedge against inflation should have established itself more or less as common knowledge. Investors use it to protect themselves against the erosion of their purchase power. However, the development of gold in a deeply deflationary environment has not been  subjected to much analysis. The only relevant period that would lend itself to comparison is the Great Depression of the 1930s. However, those were the times of the gold standard, i.e. the gold price was fixed.

By 1934 the industrial production had fallen by 50%, and the unemployment rate was up at 30%. Governments around the world had to step up their spending drastically and stop the price slump. The Western currencies were gradually depreciating. However, the economic situation the USA was in in the 1930s could not be compared to the current scenario. Whereas the country used to be the big creditor nation, it has now turned into the single biggest debtor. We can try to establish how the gold price would have developed by analysing the subsequent depreciation of the currencies after abandoning the gold standard. Great Britain depreciated the pound in September 1931 by 52%, and the USA followed by appreciating gold by about 60% in 1933 (from USD 20.67 to USD 35/ounce).

Percentage Depreciation of Selected currencies versus Gold - end of March 1934 as compared to gold parities 1929

This means that enormous buying pressure had been building up during the period of the gold standard. When in 1933 the gold reserves had fallen to the minimum requirements, President Roosevelt instructed that all private gold holdings be confiscated. All gold exports were discontinued, and the dollar depreciated massively against gold.

Gold shares, on the other hand, were going from strength to strength. The development of the most important gold producer, Homestake Mining, can serve as reasonably approximate series for comparison. From 1929 to end-1935, the share price increased from USD 75 to above USD 500, and dividends totalled USD 130. However, the strongest increase only happened after the period of deflation (1929-1932) and as the sudden onset of inflation (1932-1935). We would envisage a similar scenario for the future. The stability of the gold shares during the general crash on the equity markets was probably due to the fact that the gold price was fixed and the revenues of the producers were therefore stable, whereas all other commodity prices collapsed.

Homestake Mining vs. Dow Jones 1929-1937


Other gold mining shares outperformed the market at impressive degrees as well. Dome increased from 1929 to 1936 by almost 1,100%, and Battlemountain shares soared by 1,200%. That said, the performance came also on the back of substantially increased resources, higher production, and improved margins.

Gold AND silver have always been the only two metals of monetary importance and also have a highly positive correlation. Therefore it should be possible to resort to the price of silver – which was not fixed – as well for comparison’s sake. In 1931 and 1932 shares fell by 42% and 51%, respectively, whereas silver fell by 8% in 1931 and by 16% in 1932. Gold should have outperformed silver in this environment, given that silver is much more integral to industrial production and gold is influenced by demand that is contingent on the economic cycle to a much lower degree.

Seeing that in periods of deflation, cash outperforms all other asset classes, this should also apply to gold. Especially in an environment of expansive central bank policy, gold is surely a currency of highest quality and should therefore outperform the market. This means that gold seems to be an excellent investment also in times of deflation.

Averag Gold Price since 1900


Myth # 6: Gold does not have the relevance that it used to in today’s modern society
If this were the case, the central banks would have already sold their holdings. But the truth is that central banks – outside the Central Bank Gold Agreement – are now net buyers of gold, because it is the only reserve currency that is not contingent upon a promise of an obligation to another institution or nation. On top of that, gold is becoming more and more essential to industrial use, e.g. satellite parts, wind and solar power, the computer industry, or laser technology, due to its unique characteristics. Even if the quantities are only marginal, they multiply to sizeable magnitudes. Gold has a number of characteristics that make it a unique commodity:

– owning gold is not contingent on the promise of any government, institution, or person

– portable and easily transportable

– almost indestructible

easily identifiable

easily divisible

high value density (= high value/weight and value/volume ratio)

worldwide accepted universal currency

Myth # 7: Gold is only a crisis investment
This would have been true for anyone who bought gold in the cyclical high of 1980; however, the most rapid increase lasted only three months (end of 1979 to beginning of 1980). A comparison of gold with equities puts this statement into perspective. It took the Dow Jones index until 1954 to pass the previous highs of 1929 again. The Nikkei is still a solid 75% away from its all-time-high in 1989. The Dow Jones has achieved a cumulated performance of 1,400% since 1971. In the same period, gold – not fixed anymore after 1971 – has increased by a factor of 27.

Gold versus the S&P 500 since 1971 (start value stnadardised at 100, both in USD)

In addition, many studies have shown gold as part of the portfolio to reduce overall risk and improve performance. Gold dampens the fluctuations especially in highly volatile periods, and there is no statistically significant correlation of gold and economic data. Therefore gold is highly  recommendable for diversification purposes.


10 Year Correlation of gold versus other major asset classes Real Estate, US Bonds, International Equities Cash, US Stock and Gold - up until July 2009

This Extract is taken from Erste Group Research Report  "Special Report Gold" published in July 2009. We have republished an extract here with permission of Erste Group Research. All rights remain with Erste Bank Group, no reporduction is permitted without seek prior permission from the author.

 You can access the full report by clicking on the attachment below or by following this link to the Erste Research page.

About the author – Ronald Stoeferle
During his studies in business administration and finance at the Vienna University of Economics and the University of Illinois, he worked for RZB in credit derivatives trading. After graduating, Stöferle joined Vienna based Erste Group, covering Asian Equities. In addition he started writing reports about gold back in 2006. The upcoming annual gold reports "a shiny outlook" and "in Gold we trust" drew international coverage on CNBC, Bloomberg and the Wall Street Journal.  In 2009 he took over coverage for crude oil. Stöferle is a Chartered Market Technician (CMT) and currently completing the CFTe program.

About Erste Group Bank
Erste Group was founded in 1819 as the first Austrian savings bank (“Erste oesterreichische Spar-Casse”). In 1997, Erste Group went public with a strategy to expand its retail business into Central and Eastern Europe.

Erste Group’s customer base has grown through numerous acquisitions and organic growth from 600,000 to 17.3 million, of which 16.2 million clients are citizens of the European Union and benefit from the stable EU regulatory framework. These countries benefit from the stable EU regulatory framework. More than 52,000 employees are serving clients in over 3,000 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine).



Mark OByrne