The Purchasing Power of Gold

- Dugald Malcolm, Montreal, Canada

It sometimes easy to forget, with all the euphoria around the price of gold hitting record nominal highs and money being made trading the yellow commodity, the true purpose for holding as part of a diversified portfolio. It is not to crank up your portfolio returns or make you rich over night – leave that to the gold prospectors and miners. The true reason to have gold is an insurance policy. It is there to protect you against world uncertainty and questionable fiat currency. It is a store of wealth not a speculative gamble.

What is truly remarkable about gold is its ability to maintain purchasing power. The example often used is one ounce if gold’s ability to by a complete men’s outfit. In the times of the Roman Empire, an ounce of gold would buy a Roman man a fine toga, a leather belt and some new sandals. Today, that same ounce of gold can by a man a fine suit, a leather belt and new pair of shoes.

It is for this same reason why it is interesting to use gold to measure the value of other thing we normally only look at in terms of dollars or other currencies. This next chart is one of particular interest; it measures the S&P 500 in terms of gold. The ratio is really quite fascinating:

What this shows us is that while there has been a remarkable recovery in the markets over the last two years vis-à-vis the dollar, the performance of the S&P 500 has been less than stellar when measure in gold. In fact, the recent market highs have been unconfirmed by the S&P 500/Gold ratio, with the index far from its highs made back in August of 2009.

This chart reveals to us that much of the nominal gains in the market since March of 2009 might very well not stem from investor perception of increased corporate profitability going forward but from inflationary expectations instead.

Take this chart as a warning sign of potential inflation ahead and use it as a reminder of why gold should always have a place in your portfolio. Stock markets, bonds and currencies will rise and fall, but at least you’ll always be able to afford the proverbial new suit.

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