Saturday, July 29, 2000

The Sophisticated Investor

Good as gold? Treasury bonds are better

By John Waggoner
USA Today

        Dear investor:

        Did you know that at any minute, the stock market could CRASH, WIPING OUT your LIFE SAVINGS? Did you know that the U.S. DOLLAR could become WORTHLESS because the FEDERAL RESERVE BOARD is dominated by AUSTRALIAN MARSUPIALS? Did you know that you could live like a KING while everyone else STARVES if you follow our SIMPLE PLAN for POST-NUCLEAR PROSPERITY?

        If you're like most sensible people, you laugh and toss out pitches such as these, which often tout in vestments in gold or gold mutual funds.

        But if you do want some protection from financial disaster, you might be better off investing in U.S. Treasury securities instead of gold.

        Many people would define a financial catastrophe as a bear market. With good reason. Millions of investors' retirement plans are invested in the stock market, and bear markets are not uncommon. There were 30 bear markets in the 20th century, according to Ned Davis Research. The median bear — half were worse, half were better — pulled the Dow Jones industrial average down 27 percent.

        The very worst bear mar kets can be humdingers. For example, the 1973-74 bear market ripped the Dow Jones industrial average for a 45 percent loss in 1973 and 1974. It was the second-worst bear market in history, second only to the 1929-32 bear, which tore 89 percent from the Dow.

        While most long-term investors can stand the average bear market, big bears such as those in the 1970s and the 1930s could wipe out an entire investment plan. So for many years, financial planners recommended putting 5 percent of your assets in gold bullion or gold mutual funds as a hedge against financial catastrophe.

        Why gold? Two reasons.

        First, gold is the traditional antidote for inflation. The government may be able to print more money, but it can't make more gold. And when the value of paper money plunges, people instinctively put their savings in gold.

        Second, gold is also the investment of choice if you're worried about the fall of civilization. Should the U.S. government col lapse, gold bugs argue, its currency will be worthless.

        In the 1970s, when inflation was at its peak, gold funds proved their worth. These funds typically invest in stocks of gold mining companies, not the metal itself. The average gold fund rose 227 percent in the 1970s, vs. 103 percent for inflation, as measured by the consumer price index. The Standard & Poor's 500 stock index rose just 77 percent with dividends reinvested.

        But since then, a curious thing has happened. Inflation has risen 123 percent since 1980. The average gold fund has risen just 15 percent. The past decade, gold funds are down 38 percent even though inflation is up 32 percent.

        What gives? It may be that inflation simply hasn't been severe enough to trigger a flight to gold. It may also be that gold's ability to fight inflation is overrated. The value of the U.S. dollar was pegged to gold in the 19th century and through much of the 20th century. But the country had several bouts of inflation then, as well as two massive periods of deflation: one in the 1830s and another in the Depression.

        It may also be that gold has been demonetized — that is, its power as a medium of exchange has been overtaken by the U.S. dollar. For example, when the world's currencies threatened to crumble in August 1998, some investors bought gold. But most went, overwhelmingly, to U.S. Treasury securities. The rush to Treasuries pushed their yields lower, and their prices higher.

        If you're worried about long-term inflation prospects, you may be better off lining your portfolio with inflation-adjusted bonds, rather than gold. The U.S. government guarantees these securities, and their prices rise when inflation does. You can buy them through your broker, or directly from the U.S. Treasury. Find out how at

        If you're worried about global instability, a government securities fund might be the ticket for you. During the global currency crisis, the S&P 500 fell nearly 18 percent. But government bond funds rose 3 to 5 percent. That wasn't enough to cover your losses, but certainly helped cushion them. The best funds for the past five years are in the chart.

        What if you're worried about the fall of civilization? You could buy gold bullion and bury it in the back yard. But at that point, hedging your portfolio will be the least of your worries.


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