It's all true enough: Gold generates no periodic cash flow and has no terminal value. It's also true that gold has no investment value. Nevertheless, analysts are confronted with a niggling cognitive dissonance: If gold has no investment value, why, then, is someone on the margin willing to forsake $1,100 for an ounce of the stuff? Gold is shiny and can radiate a mesmerizing luster, but few people are so mesmerized to the point to pay a seemingly punitive price for pure luster.
Nomenclature is more likely the issue. To find gold alluring as an investment is as nonsensical as it is to find a cat alluring as a dog. Gold is not an investment; a cat is not a dog. Nevertheless, gold is wrongly slotted into the investment species, and there it attracts scorn for its non-investment properties.
Perhaps history is to blame. Analysts are prejudiced by decades of precedence. Since the late 1930s, they've been inculcated on the analytical stylings of John Burr Williams: no expected future cash flow, no value. Williams' techniques imbue investment analysis with the patina of scientific methodology, just ask any analyst who has had to endure an Excel spreadsheet presentation. But it's nothing more than a patina. After all, every analyst's expected future cash flow is wrong. And as for the required rate of return for the discounting? That's a personal matter. Discount rates aren't delivered like manna from heaven; they are conjured from within. Nevertheless, orthodoxy reins. Based on the underpinning of discounted cash flow precepts, gold cannot rightly be valued as an investment; hence, the scorn.
But gold can be rightly valued as an asset, and assets need not be investments. There is no shortage of assets that create value -- monetary or physic -- that generate no intermediate cash flow and have no determinable terminal value. Nearly all the consumer goods in a home (along with the home itself) are assets. Some even appreciate. Most produce no cash flow and are valued solely for use. To be sure, most consumer assets possess a degree of trade value. In a pinch, the car, the couch, even the cat, can be monetized in a sales transaction. Because these non-investment assets have value, they are insured.
And therein lies gold's value – insurance, Specifically, gold insures the purchasing power of money. That gold insures money isn't terribly dissimilar to negative-yield government bonds insuring money. Paradoxically, analysts treat negative-yield bonds as investments, though the bonds yield no cash flow. To the contrary, they consume cash flow. Why, then, are negative-yield bonds valued and bought? They are bought to ensure receipt of a specific amount of cash at a specific date in the future. Given the precarious financial standing of many European banks, along with the inclination to change established rules mid crisis, it's understandable that someone willingly pays to warehouse his euros or Swiss francs in negative-yield bonds.
Money insurance is equally the focus with gold. Contrary to pervasive belief, gold goes not insure against the financial fallout from disaster, upheaval, mayhem, volatility, or uncertainty. It insures against inflation. Here, another misconception must be slayed: consumer-price inflation, which is at best an ethereal construct.
Like any aggregate, average, or median, a statistical agglomeration of numbers is meaningless to any individual. Unless someone buys the exact components of an index in the exact proportions, the index reveals nothing about his or her situation. Every individual has a bespoken CPI that likely has little in common to the Bureau of Labor Statistic's CPI or the Bureau of Economic Analysis's Personal Consumption Expenditures (PCE) Price Index. To attempt to ensure the ethereal -- a general price index -- is folly.
Properly speaking, gold insures against monetary inflation, which must be distinguished from consumer-price inflation.At a point in time it's possible to have one, but not the other. To be sure, money supply is a variable in consumer prices, but so are technology, productivity, and shifts in the supply and demand curves. It's possible for the money supply to rise and consumer prices to fall: consumer electronics, for example. Consumer prices can fall when there is monetary inflation (and they would likely fall more without monetary inflation). To go farther afield, though, the positive correlation generally holds: When money supply increases relative to goods and services, given enough time consumer prices rise and purchasing power is lost.
In short, gold insures against an increase in the money supply and its corollary, lost purchasing power. The graph below displays the gold price and the theoretical gold price based on money supply growth over the past 45 years.Over time, gold does the job of maintaining purchasing power diminished by money debasement.
Actual Gold Price (Ounce) and Theoretical Gold Price (Ounce)
Data Source: Paul van Eeden / Cranberry Capital*
In the modern era of government central banks, fiat money, and fractional reserve banking, that gold serves as insurance to maintain purchasing isn't difficult to understand, though many do. Gold works as insurance because of its established moneyness: Gold has high exchange value; it's scarce, durable, divisible portable, fungible, generally unconsumable, accommodatingly rare, and widely recognized.
So when someone tells you that gold has no investment value, nod your head in agreement. Then counter that gold has plenty of insurance value.
*Economists quibble over what should be included and excluded from money supply. van Eeden's data use currency, DDAs, and short- and long-term time deposits. For expediency's sake, I won't quibble. van Eeden's data are persuasive to me because they confirm my bias.