Jason Zweig has a couple of good pieces in the WSJ today on gold (see here and here). Jason is not a big fan of owning gold in a portfolio and I generally agree with him. However, I don’t completely agree with the description of gold as a “pet rock” and I think it detracts from the point he’s trying to make. So let me see if I can make a similar point from a more empirical perspective.
I like to work from what I think is a form of rigorous empiricism. I tend to think like an engineer so I always ask how things are constructed before asking how they can be used. For instance, a stock is a financial instrument giving the owner a claim on a corporation’s future profits and since we reside in a capitalist system a fairly high probability bet is that corporate profits will rise over time which will make an aggregate index of stocks more valuable across long periods of time. A bond is a slightly different type of financial instrument (usually) giving the owner a fixed income stream as defined by the terms of the contract. This instrument will generally underperform stocks because the income is a current expense for the company which reduces profits. Assuming the company is using the bond to finance growing output it’s safe to assume that stocks should beat bonds over long periods of time because stocks give you a claim to the residual income that bonds finance.
Those are really simple, but fairly empirically grounded understandings of some of the instruments we use in the financial system. Gold, however, is very different. So, what is gold?
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