Don't Be Glamored By Gold

By Sham Gad | September 05, 2011 AAA

Investors will be eager to forget the month of August 2011. Despite the mini rally that occurred over the last few days of the month, August was a terrible month for equity investors. The S&P 500 declined by over 5% in August, one of the most painful months for long equity investors since the 2008 financial crisis. Gold, on the other hand, has been a glamorous performer in August, up by over 12% and thus outperforming the S&P by 17%.

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Glamor Doesn't Last
Gold is indeed a hedge against monetary disorder. If markets panic, gold goes up and that is the way it will be. If the Fed institutes QE3, gold will likely go up in response to increase in supply of dollars. But at over $1,800 an ounce, investing in gold may not be the best alternative. During the past 30 days gold has outperformed stocks, but investing is not a 30 day activity. Even over the past five years, gold, as measured by the SPDR Gold Trust ETF (NYSE:GLD), is up 190% while the S&P is down 9.5%, making it seem that gold has been the winner. Yet over that same time, AutoZone (NYSE:AZO), the largest auto parts retailer, was up 242%. Apple (Nasdaq:AAPL), a name everyone is very familiar with is up over 450% over the past five years.

Cash Flow versus Sandcastles
Names like Apple and AutoZone have appreciated in price over the past five years because they have been able to increase their earnings and cash flow, thereby increasing intrinsic value. Gold produces no cash flow and has no utility save for jewelry which is ultimately melted back into gold to make more jewelry. Gold appreciates by psychology. I don't discount the value of psychology; but I also question investing based on it.

Looking at the next five years, investors will likely fare better buying solid cash-generating businesses over simply holding gold. With all of the monetary stimulus occurring in the world today, gold may continue to appreciate significantly. But so can a business like Oshkosh Corporation (NYSE:OSK) that provides equipment and vehicles to a wide variety of industrial consumers as well as the U.S. Department of Defense. Shares have fallen hard in August, but the company produces gobs of free cash flow.

The Bottom Line
While gold serves its purpose in this world, the true value of any assets is the discounted present value of its future cash flows. Since gold produces no cash flows, its valuation is not linked to fundamentals but instead to emotion. (For additional reading, take a look at Does It Still Pay To Invest In Gold?)

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