Why to Own Gold

Gold doesn’t receive much thorough, academic attention as an investment. It’s generally the province of gold bugs, gold haters, and technical traders. That’s why I’m interested in this paper from Claude Erb of TCW and Campbell Harvey of Duke University. There’s a lot of detail in the paper, covering both the demand and supply for the metal. One finding in the paper is that historically (since 1975) gold hasn’t been much of an investment and hasn’t really been a good inflation hedge. The paper also uses strong analysis to debunk many of the truisms about gold that influence investors. But the big conclusion of the paper is that gold generally appears to be underowned and a good case can be made that demand will increase in the coming years, generating positive returns even at today’s relatively high prices.

We find little evidence that gold has been an effective hedge against unexpected inflation whether
measured in the short term or the long term. The gold as a currency hedge argument does not seem to
be supported by the data. The fluctuations in the real price of gold are much greater than FX changes.

Anyways, for a particular currency pair, even if gold hedges one country’s currency, it cannot hedge the
other’s. We suggest that the argument that gold is attractive when real returns on other assets are low
is spurious. Low real yields, say on TIPS, do not cause the real price of gold to be high. There is some
other economic force, perhaps a fear of inflation, driving variation in both TIPS and the real price of
gold. We also deconstruct the safe haven argument. We focus on hyperinflations in major countries
(because smaller countries that fall into hyperinflationary episodes might simply adopt another
currency, such as the U.S. dollar, as their de facto currency). Our analysis shows that the price of gold is
very sensitive to even a remote possibility of another Weimar Republic?like inflation episode.