Is Gold an Investment? Nominal Return vs. Real Return

Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler, talking about the money and investing world. We’re doing our best to explain this in a way that doesn’t give people haircuts.

I’m here with Jim Wood. Jim, do you find sometimes this stuff gives people haircuts where they’re just going, “What did you just say?”

Jim Wood: Yeah, I’m not sure I was familiar with that phrase.

PW: Oh, yeah, when people do that, you say something and they go —

JW: Oh, that’s like going over their heads.

PW: Right.

JW: Right, right, but yeah.

PW: Or give them haircuts.

JW: Yeah.

PW: Yeah.

JW: I haven’t heard that phrase. That’s a new one. I’ll have to add that to my repertoire.

PW: I probably just made it up and it doesn’t exist.

JW: Yeah. Well, I kind of do need a haircut.

PW: Yeah. No, that wasn’t like a subconscious thing for me.

Gold as an Investment

PW: There’s a thing that I thought I’d throw by you, the first thing to start off with, that I think gave somebody a haircut this week, and I wanted to do a video on it.

That’s basically what I do: I do videos on things. If you happen to be subscribed to our channel, I don’t even know how it gets distributed — on our YouTube channel, I know it goes out there on that — but it was about gold.

I was in a group of people having lunch, mainly ladies around the table, and we were just talking about stuff over where I do some counseling work. Anyway, what happened is the question came up about gold as an investment.

I said, “Well, what do you think about gold?” I go, “Oh, that’s one of the most common questions I get.”

But I’m telling you, if it’s coming up here, there are a lot of people that still have that question. There was something that came up in the course of the conversation that I had not heard, and I want to hear your response to it, and I’ll give my response afterward, and a couple of thoughts afterward.

In effect, on the idea of gold as an investment, well, go ahead, Jim. Give what you typically tell people.

JW: Well, I think gold is great as jewelry. We’ve kind of talked about that before. It’s not so great as an investment. It has no products.

It has no return. It has no services. It has no inherent return. It’s a commodity.

PW: It has return, it could have return.

JW: Yeah. I mean, it’s typically gotten roughly inflated over time, and it’s what people are willing to pay you.

PW: So what he’s talking about here, folks, is no real return. There’s a difference between nominal return and real return, and the difference is nominal return is just something that goes up in value.

The question is, did it go up in value more than the inflation rate, or did it go up in value more than the dollar went down in value?

That’s another way of looking at that. That’s what Jim is referring to.

JW: Right. Just the fact that it’s only really worth what somebody else is willing to pay for you.

It’s a lot of people saying, “Oh, it’s a store of value and I want it in case everything comes crashing down.” To me, I’ve always thought, Well, the only really good that gold’s going to have in that situation is it’s heavy enough to go over and bonk your neighbor over the head with it and try to take their food, because that’s what you really need at that point if everything’s really falling apart.

“The Twilight Zone” Example

PW: Well, that’s exactly what happened in “The Twilight Zone,” wasn’t it?

JW: Yeah. That one episode, sure.

PW: Yeah, so you don’t know what I’m talking about, folks. It’s just that I did a TV thing years and years ago.

I was on Channel 5 and did this thing where — I don’t know how I got away with it — I showed the portion of a video from “The Twilight Zone,” and these guys basically had robbed a train of gold. What happened is they’re walking and going into this cave where they’re going to put themselves. One of them is a genius who figures out how to actually put people to sleep so that he can wake them up years and years later.

He puts them all to sleep for a hundred years, and the idea is that when they wake up a hundred years later, nobody will remember the train robbery. That’s the way the whole thing goes.

Well, they wake up. One of them didn’t make it because of I guess a stalactite, which is the one that hangs from the ceiling, right? Stalactite hangs tight to the ceiling.

Has a C, ceiling, ground G. C ceiling, G ground.

There you go. That’s the way my dad taught it, so it fell and hit the glass, it looked like a casket sort of that they were in. There was a gas in the casket that made them go to sleep, and he didn’t make it. He was just a big bag of bones.

Everybody knew — oh my goodness, it must be a hundred years later because he’s all bones — that they’re awake and they’re getting out of the cave, and they have all this gold and everybody they knew is dead, and everybody that would’ve been looking for them is dead because basically it’s a hundred years later.

They’re going through the desert, and every once in a while, one of the guys runs out of water and he goes, “Oh my goodness, I don’t have any water.” He goes, “Can I get some water off of you?”

The other guy goes, “Yeah, for a bar of gold.” Then finally what happens is he runs out of gold completely, and he doesn’t have any more to get, and he needs another drink of water. He says, “I need another drink of water.”

He goes, “Well, you got no gold left,” and he takes the gold and bonks him over the head. That was it.

Come to find out, and this is the reason I used this in the TV show, he comes up and these people are flying this space-age craft and they’re going, “Hey, there’s this guy begging for water. He’s willing to give us all his gold,” because he bonked the other guy in the head and took all his gold from him.

The point is this: What did that guy want when push came to shove? A drink of water.

What did he have to give for it? Gold. What was really ironic, I’m going to ruin the end of it for you, was that this woman goes, “Hey honey, this guy is going to give you gold for a drink of water. Didn’t they figure out how to manufacture that?”

Then he goes, “Yeah, so what’s it worth? Nothing.”

Increased Supplies of Gold

PW: It was just kind of ironic on a couple of different levels because if the value of gold goes up so much, then what happens is now you give the incentive for people to mine for more of it, and you increase the supply.

What happens when you increase the supply of anything? The value of it drops because of that.

It may be that, who knows what it is? It may be that people have had store value for many, many, many years, but all of a sudden, a big hit happens, like when they had those rainstorms in California.

All of a sudden, these gold supplies — now we actually see them. Now you can actually get gold because the water had moved all the sand and the silt and everything, and now the gold was showing up and that increases.

So you just never know. Anyway, gold, you look at it and go, “Well, it’s a store of value, a store of value, a store of value,” but it has not gone up by more than the inflation rate as Jim has been talking about.

Well, I think you get so many questions on that because people are so bombarded by advertising on gold. That’s why the questions come up, not because it has a great track record or people have been super successful with it over time or anything like that.

It’s because there are constant messages. “You need to buy gold, you need to buy gold, you need to buy silver,” especially on radio and TV and certain channels and stuff like that. They push, push, push that message, and so people think, Well, maybe that’s something I ought to be thinking about.

Then what they’ll do is they’ll buy it. They’ll buy it, and demand increases for it because of the commercials, and that increases the price — the demand for it increases the price. Then people take from that that it’s a good investment because the price has recently increased, and they don’t think about what the reason it increased was due to. It was due to demand because of all the commercials and all the advertising.

It has these huge run-ups, right? It does have some short-term run-ups, and that’s when the advertising goes full force.

If you look at the long-term return, as we talked about earlier, it’s about what inflation has been, but it has enormous volatility so it’s kind of the exact opposite of what you want in an investment: Low return and high volatility. Ideally, the perfect investment would be high return with no volatility, but that doesn’t exist either.

You could look at it and say, “Well, it increases because of inflation. We’re going to have huge inflation.”

I point back to times when we’ve had huge inflation — the 1980s and early 1980s, late ’70s, early ’80s — and then all of a sudden what happened was gold dropped in value, so it’s not necessarily a great correlation. As a matter of fact, the correlation relationship is pretty poor when it really gets down to it.

You would think, Well, that doesn’t make sense. It should be a high correlation.

Long-Term CD Returns

PW: One of the things that came up, which was interesting in terms of this conversation is I said, “Okay, here’s the way I like to explain it to people.” We look at something like a CD and that CD pays 3% interest, and I’ve done this a couple of times in recent weeks in the show, so just bear with me on this.

If I have a CD that pays 3%, if I have $100, it will pay me how much per year? $3.

3% of 100 is three. I know I’m going to get the three.

Let’s say that it’s a long-term CD, let’s say it’s going to go for 10 years or something like that, just so you get the concept. It’s going to pay me $3 this year, next year, the next year after that, next year after that, next year after that, and the next year.

So it’s going to pay me $3 every single year if I have such an investment. I know that I have some investment and I know that it’s a CD and I know that it pays 3% and I know that it pays me $3 per year, so I can tell you definitively that it is worth $100 because I can do the math backward.

I can go 100 times 3% equals three. Well, if I know the number three and I know the 3% in the other part of the equation — so I have X times 3% equals three.

If I know those numbers, then I could say, “Well, I can do algebra.”

Some people can’t. I can. I still can.

I have to tell you a personal story. You ready for this?

JW: Sure.

PW: I was so distracted when I was in high school that I flunked my first algebra class. Oh my goodness, it feels good to admit that publicly. I was very distracted as young guys tend to be when they’re in high school.

JW: Yeah, but was it drums or was it girls?

PW: It was drums.

JW: Oh, okay.

PW: Yeah. That is so interesting that you picked up that it wasn’t necessarily girls; it was drums and it was music.

I was so distracted and I hated algebra so much, because it was so boring, that I just didn’t pay attention. What happened is I flunked and I went, “Oh my goodness.”

That was my wake-up call for the rest of my life that I had to actually get my act together. The next time I took it, I got close to 100 on it. I mean, I really knocked it out of the park next time.

Anyway, that has nothing to do with gold. How do I do this? So 100 times 3% equals three.

If I’m looking at a CD and it pays 3%, I know I’m going to get $3 for every hundred. I know how to do this formula backward. I can go, if I don’t know the first number, 100, I can go, “Something’s paying 3% and it’s going to give me $3. Oh, it must be worth $100.”

I hope that makes sense because it was something that when I was talking to these people, they were like, “I don’t quite get what you’re saying, Paul,” but I think they finally got it. I think they finally got it.

Historic Return of Gold

PW: Now, here’s the issue: I’ve got this thing called gold selling for X number of dollars an ounce, and I’m trying to figure out what the value of it is. I look at it and go, “Well, what’s it paying?”

How much is it paying, Jim? How much is gold paying? What is the payment when I hold it? What is the payment that I get every month or every year or whatever?

JW: That would be zero.

PW: That would be zero. Yeah, very good. That would be zero, that’s exactly right.

So I don’t get paid anything, and here’s what they came back with, which kind of shocked me a little bit, “Oh no, it has a return. It has a return.” I was like, “Whoa, wait a minute.”

Michael here in the office up in Goodlettsville made a comment, and I really liked this. I liked what he said because I was thinking about explaining this in terms of dividend-paying stocks. Now with a dividend-paying stock, you get a payment of the dividend, then you get the appreciation of the underlying value of the stock.

He used real estate in the way he explained it. If you think about it, you have two components that give the return historically of real estate, the rental value of the property, which is the rental payment, so somebody might be paying you $2,000 a month to use your property, but it also can appreciate in value. The house can go up in value.

Now, the reason that the house went up in value is what? Inflation.

And this is the further conversation we had: Can it go down if we have inflation? The answer to that would be yes.

In the 1980s when tax laws changed regarding real estate, real estate went down in value. We had lots of inflation in that particular period of time, but that didn’t mean that real estate was going to go up.

Just get, folks, that gold is a thing that goes up and down in value. Its historic return has basically been zero after inflation.

It’s a good man’s suit 100 years ago, an ounce of gold. A good man’s suit today, an ounce of gold. No appreciation in value. I think it’s important to remember that.

Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.