What role does gold play in a buy-and-hold investor's portfolio? Earlier in June, I discussed that issue with Eddy Elfenbein, who writes about investing at Crossing Wall Street and was named by CNNMoney as "the best buy-and-hold blogger" on the Web.
Watch our conversation here (run time: 5:06), or read the transcript below:
Brian Richards: Let's talk about gold for a second. Gold has gained popularity almost out of nowhere in the last three or four years really since the crash, and people are waiting.
Eddy Elfenbein: You haven't been talking to gold bugs have you?
Elfenbein: Let me tell you about the religion of the gold bugs. And I really do love gold bugs because they are people who just get so wrapped up emotionally in this metal, and it's fun to watch. But gold is an asset like no other. Gold has been a dream of mankind since the dawn of time. Gold is mentioned in the Bible hundreds of times. Gold never rusts, did you know that?
Richards: I did not know that.
Elfenbein: You can go into King Tut's tomb and you can take the gold out and use it as a filling in your tooth. I mean you have to clean it off first, [laughs] but it's not rusted. And you can use it, it just might be dirty.
Something else, gold is incredibly soft. If you take one ounce of gold you can stretch it out for 50 miles. There's nothing else like gold. And this is what I find fascinating. This is how I'll describe gold is gold is a currency, or I would say more appropriately it's the anti-currency. Gold is the currency that keeps all the other currencies honest.
Now, when you think of a dollar bill that you carry around in your wallet, every dollar bill has an interest rate tied to it. We don't think of that, but that's what a currency is. It's a little walking interest rate. Every currency in the world has that and that's what makes it valuable to whatever level. Now with that interest rate there is sort of -- I don't know how to describe -- kind of a global phantom interest rate, a real interest rate that is in ballpark it's about 2%. And that is sort of what the global kind of growth rate in real terms is. And every currency in the world is measured against that 2%.
That becomes the replacement level for gold. It's almost like if I were to take a light and shine it in Plato's cave and what you don't see, that's gold in the way that gold is a currency. So whenever real rates fall below -- this is at the short end -- fall below about 2%, that's when gold rises. That's when gold does well, because it's trailing. It's not that gold is going up; it's the dollar is going down. And then conversely when gold goes above 2% in real terms, that's when gold falls very, very sharply. Now there are some interesting takeaways about this -- that gold is not a buy-and-hold investment at all. It is one to own in very particular times.
The other thing is that gold is subject to political pressures. The Federal Reserve can kill gold tomorrow if it wants to by raising rates. That would just wipe gold out instantly. So when you're a gold investor that's what you're tied to. It's been below 2% basically almost for 10 straight years. In very rough terms, for each percent that real rates are below 2% -- so if real rates are at 0. Gold traditionally goes for about eight times the distance you're from 2%. So if real rates are at 0, you're 2 points from it, then gold rises by an average rate of about 16%. And this is an average over many years, but it's held up surprisingly well.
People who invest in gold need to understand that you're investing in the not-dollar. That's what you're doing as much as you're buying gold. But the key is it can rise very, very quickly if the times are right, and then when things turn against it, it falls very, very sharply. And if you look at the history of gold it's a series of spikes and crashes, spikes and crashes.
The article Gold: The "Anti-Currency" That Keeps All Currencies Honest originally appeared on Fool.com.
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