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I get the most mail whenever I write about gold. The point I try to stress is how poorly gold has performed relative to common stocks. What’s interesting is how little gold has to move for gold bugs to claim victory.

If there’s one thing I can get across to investors it’s that gold is an asset, but stocks are equity. This is a huge point. By it, I mean that gold only has value for what people can do with it. Stocks, on the other hand, represent claims on real assets. It’s people taking assets, like gold, and using them to create wealth. It’s people actually doing something. Gold is merely the tool, and it has very limited industrial applications.

The price of gold has historically been defined by brief and dramatic price spikes, followed by periods of long declines. I think we’re going through a spike now. In fact, it may already be over.

A few days ago, Barry Ritholtz posted a chart from Chart of the Day showing the Dow-to-Gold ratio. For 20 years, the ratio had dramatically expanded, although it’s fallen in half during this decade.

Of course, gold doesn’t pay a dividend so I was curious how dividends would have changed this relationship. Dividends don’t pay much these days, but the effect over 30-odd years can be pretty big. Also, small-cap stocks have done very well over the past few years so I wanted to compared Gold against the Wilshire 5000 Total Return Index (^DWCT). Here’s what the chart looks like:

That's a logarithmic chart, so you can see that the ratio has grown very dramatically over the years. In 20 years (1980-2000), stocks beat gold by an amazing 72 fold. Gold's advantage over stocks during the past few years is truly just a small dip in a long-term rise.

Posted by edelfenbein at October 24, 2006 1:53 PM