While Shakespeare punishes his character in tragic-comedy The Merchant of Venice for choosing gold to win Portia's hand in marriage, "punishment" doesn't always happen in real life. In face, over the past decade commodity markets have richly rewarded investors who choose gold to "...gain what many men desire," as the Bard wrote in the play.

From June 2001 to June 2011 a troy ounce of gold appreciated by more than 450%. An ounce of gold's poor cousin, silver, appreciated by even more, that is 700% over that same period. Contrast that appreciation with the S&P 500 U.S. equity index that gained just under 8% (slightly more than 30%, if you include reinvested dividends) during that time. It's no wonder that investors' attention has focused more closely on precious metals than at any time in the past 30 years.

In contrast to gold's rapid appreciation during the 1970s, the past decade's run failed to reflect a contemporaneous rise in the nominal price of the goods and services we buy and use. In fact, the U.S. along with Japan and several Western European countries actually faced the threat of deflation several times in recent years. This time gold's price in dollars owed more, in my opinion, to concerns about the long-term exchange value of paper currencies, especially the dollar. Note that during the 10-year period in which the dollar price of gold increased by 450%, its price in euro and yen increased a lot, but by considerably less, that is 223% and 257%, respectively. Recall that these 10 years were marked by easy money in the U.S. and a deteriorating current account deficit and then by the Federal Reserve's two waves of aggressive balance sheet expansion in the aftermath of the 2007-2008 financial crisis.

In an era of fiat money — money that has value only because a government says so — central banks can print, electronically, all the money domestic legislation and their own prudence allows. Print enough money and its purchasing power will erode. I believe over the past decade, investors' confidence in monetary policy has frayed and their willingness to pay ever higher prices for gold has strengthened. Some of the markets' concern about U.S. monetary policy shows up in other currencies. The euro, for example, appreciated by about two-thirds between mid-2001 and mid-2011. But it is precious metals that have enjoyed the flight from paper currencies the most.

So now what? After all, gold itself doesn't always "glister" quite so brightly. For the decade between June 1991 and June 2001, the price of a troy ounce declined by over 25%, while the S&P 500 appreciated by almost 230%, over 300% with reinvested dividends. The difference between the two 10-year periods, in fact, makes the most important point for investors: Gold tends to zig, when financial assets zag. Over most periods, the monthly correlation between gold and the S&P 500 is low, moving toward zero as the time horizon expands.

Because a gold bar neither pays interest, produces earnings nor has a business plan, it falls outside what I consider to be the core of most investors' portfolios. But as a hedge against inflation, monetary debasement or especially volatile times (note gold's appreciation as the U.S. budget impasse worsened), gold can play the role of fire insurance: There when you need it; quiet when you don't.


Dr. Jerry Webman, Ph.D., CFA, chief economist at OppenheimerFunds,
provides strategic viewpoints to investment management,
the financial advisor and investor communities.
He can be reached at this email address.

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