Gold: More than Just a TIP
It is still common for market commentators to denigrate gold as a relic of little value. They claim that since it offers no dividend its only appropriate use is for jewelry--never calling to mind the hubris it takes to ignore 5,000 years of civilization that viewed gold as money.
Most market strategists still don't realize that gold is money and its value is as a store of wealth and it holds its value against fiat currencies better than any Treasury asset, including TIPS. So, I thought it may be enlightening to compare the returns of gold versus Treasury Inflation Protected Securities and determine which offers a better hedge against inflation.
A Treasury Inflation Protected Security is a bond which increases its principal upwards by the same amount as the rate of inflation as reported by the Consumer Price Index. Since their inception in 1997, the average issued yield on the 10 year TIPS has been 2.9% (source: Dept. of the Treasury, January '97-'07 issue dates excluding 2003 issue date of 7/9). Over that same period, the average rate for the CPI has been approximately 2.5%. Thus, the average annual return on TIPS since their inception 10 years ago has been about 5.4%.
Currently, according to March inflation numbers the CPI increased by 2.8% compared to 2006 and the current yield on a 10 year TIP is 2.3%, suggesting a total return of only 5.1% despite today's elevated CPI. However, the expected rate of inflation through the life of the security is only 2.4% as indicated through the TIP's breakeven spread.
Comparing gold to the TIPS, we see the price of gold has risen from $300- nearly $700 per ounce since 1997, for a compounded return of 8.7 % per year. Put in dollar terms, the same $300 invested in 10 year TIPS since '97 would have compounded to only $536 at 5.4%-- and that is before taxes on the income received.
And this is no aberration; many investors would be surprised to learn that gold has returned an average annual compounded rate of return of 8.65% since 1971 -- the year Nixon broke the Bretton Woods agreement and severed all ties to the gold standard. Since then, gold has surged from $35- $693 per ounce (18.8 times).
For those who might say the history for TIPS is too short to draw any long term conclusions, we can also simply look back on the last 20 years of nominal Treasury yields, where we see an average yield of 6.21% before taxes. That yield is especially diminutive when compared to the average increase in M3 of 7.8% (which is closer to the actual rate of inflation) over the last 35 years.
The point is, the calculation method for the CPI is flawed and will always understate the true rate of inflation; adding such a CPI figure to the anemic nominal TIPS yield will never allow investors to get ahead in real terms. Unlike TIPS, gold offers no guaranteed rate of return, but I would rather have the millennia of history validating gold as an excellent hedge against inflation rather than a return benchmarked versus the Consumer Price Index.