House prices, gold, and long-term investing

One thing I’ve always believed about investing (as opposed to speculating) is that it’s important to step back and take a look at the long-term picture.

In the shorter term, markets are subject to periodic “manias, panics and crashes”, as Charles Kindleberger put it in his classic study of financial crises. But in the long-term, prices tend to return to rational levels.

The recent housing boom and bust across much of the world was a classic example. Take the chart below (from Christian Science Monitor this week). You can see that from 1890 to the mid 1990s, US house prices basically went nowhere after adjusting for inflation. In other words, for more than a century, house prices delivered annual real returns of close to zero. That’s a surprisingly ordinary investment record.

But something changed from the mid 1990s. In a massive credit boom, the US had a decade of near double digit returns in the property market. If you were a young first home buyer with no knowledge of history, you could be forgiven at the time for believing mantras like “house prices double every seven years”, and “property is a better investment than shares because you can leverage it more.” (Hello Australia).

This Time is NOT Different

Of course, this was later proven to be a fantasy. As the chart above shows, the massive house price boom that was witnessed in the decade up to 2007 was a once in a century anomaly driven by Ponzi finance.

Today, after adjusting for inflation, US house prices have returned to roughly the same level they were in 1894. Almost one in four borrowers have negative equity in their homes. And the crash may not even be over. In fact, the chart above suggests that if US house prices are to return to their long-term trend (of simply growing in line with the rate of inflation), they have another 20% or so to fall.

Once again, this shouldn’t come as a great surprise if you take a look at the long-term history of house prices around the world. In fact, the longest study ever done of housing prices — a house price index for the Herengracht neighborhood of Amsterdam — shows that on average, real house prices only doubled over the 380 years or so since 1628. That’s an annual return of about 0.2%.

Last week, The Economist argued that Australian house prices were overvalued by 56% compared to long-term fundamentals. Now, we can quibble about the calculations behind this and the degree of overvaluation. But history shows that it is simply impossible for house prices to keep growing at a much faster rate than inflation and incomes.

As the famous fund manager Sir John Templeton once reportedly said, “this time is different” are the four most dangerous words an investor can say.

Gold Mania

All of this brings me to what is perhaps the greatest investing fad of the current era: gold.

The gold price has absolutely gone through the roof over the past year or so as fears have grown that easy money from the Fed and skyrocketing budget deficits are going to lead to rising inflation, or even hyperinflation.

After all, if you are convinced that the Fed is printing too much money and is going to “debase the dollar”, why would you hold dollar-denominated US Treasury bonds or paper currency? Gold, which has been synonymous with money for centuries, seems like a safe choice to preserve your wealth. If you switch on Fox News, you will see hundreds of TV commercials every day flogging gold ingots, coins and other hyperinflation remedies.

Now, my fellow Macrobusiness blogger The Prince reckons gold (and silver) could be on the verge of going “truly parabolic” over the next couple of years. I don’t disagree. With rising tensions in the Middle East, the possibility of Greece and some other peripheral European countries defaulting on their debt, and growing hysteria over the US budget deficit, there is plenty to worry about in the world.

But let’s step back for a moment and look at the big picture, as we did for house prices. We’ll start at 1971, which is when the link between the US dollar and gold was officially severed.

You can see below that apart from a huge speculative boom in the late 1970s (which ended with a massive crash), the price of gold in real terms has been relatively steady for much of the past four decades.  This shouldn’t be too much of a surprise, because at the end of the day, there is nothing special about gold. Over the very long term, its price appreciation should basically be in line with the rise in the marginal cost of gold production, or the cost of extraction. And this cost tends to rise in line with the rate of broader inflation.

In the short term though, it’s a different story, and gold is special. Gold is the classic safehaven asset, and it can rise explosively in response to financial instability, war, or other sources of tension in the global economy. But the point is, there is a long-term anchor for gold prices: over hundreds of years, this has proven to be the rate of inflation minus the cost of storage. Which, by the way, is far below the long-term returns on stocks, bonds or property (which at least pays you a yield).

For a decade now, gold prices have far outpaced inflation. In fact, over the past five years, gold has delivered an annualized return of around 23%.

What does this mean? It means that if the inflationary doomsday scenario that is being priced in does not materialize, at some point gold is going to head south, big time.

As Warren Buffet said last week:

So there’s two types of assets to buy. One is where the asset itself delivers a return to you, such as, you know, rental properties, stocks, a farm. And then there’s assets that you buy where you hope somebody else pays you more later on, but the asset itself doesn’t produce anything. And those are two different games. I regard the second game as speculation.

Now there’s nothing immoral or illegal or fattening about speculation, but it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something you expect to produce income for you over time…

With an asset like gold, for example, you know, basically gold is a way of going along on fear, and it’s been a pretty good way of going along on fear from time to time. But you really have to hope people become more afraid in the year or two years than they are now.

And if they become more afraid you make money, if they become less afraid you lose money. But the gold itself doesn’t produce anything…

Buffet, of course, is absolutely right. When the fear subsides — which it inevitably will — the price of gold will plummet. And you will be left with a lump of metal that has no intrinsic value, is worth far less than what you bought it for, that pays you a yield of zero.

Gold is a useful inflation hedge, and I’m not claiming it shouldn’t have a small role to play in some people’s investment portfolios. If you really think the end of the world is nigh, go ahead and stock up on ingots. The rally in gold prices may still have a fair way to run.

But let’s not forget that gold is a highly volative, speculative investment that has quite possibly already appreciated well beyond its “fundamental” value.

Just as we’ve seen in the housing markets of the US, Spain and Ireland, no matter what asset we’re talking about, this time is NEVER different.

Latest posts by _EcoRon_ (see all)


  1. Agree Rotten Apple – I painfully try to explain to people that house and land prices should only go up with inflation (at best). The stares you get back are amazing.

    If I may make a long reply?

    I disagree with Mr Buffett – I think there are 3 types of assets or “investments”.

    Type 1 is your classical investment asset, with a calculable intrinsic value. A bond, a good company with positive cashflow etc. This should make up most, if not all of someones wealth.

    Type 2 is your classical speculative asset. This includes using derivatives to purchase a Type 1 asset, or use of leverage, or “investing” in shares in companies that don’t have cashflow or on a promise (e.g mining exploration companies) or companies that rely upon a Ponzi scheme or the height of the business cycle to make money (e.g Macquarie).

    So up to there I agree – but there’s a third class.

    The Type Zero. This is a non-yielding, non-speculative, “security asset” – that has a tangible value to the owner. Here is where property lies – i.e a primary place of residence. Your home. Your home is not an investment or a speculation. It has no yield (unless you rent it out, then its no longer your home.)

    Gold has a similar place here. It has no yield – it is not an investment if you own the physical stuff (anything else – a warrant, CFD, mining company etc is a speculation in gold).

    Its a Minsky metal – it has a time and place in case of monetary chaos and upheaval. It has no other quality. It has an intrinsic value, limited to the monetary and physical effort required to attain it – no more.

    There are other Type Zero assets: insurance (Life/Income Protection and portfolio insurance), even other tangibles like safe water supply and agricultural land.

    I’m no gold bug – Rotten is correct in stating that gold is largely treated by market participants as a speculative “investment” – note how low physical delivery and storage is compared to the number of ETF’s, CFD’s and the futures market, which has exploded in size and volume.

    There is no denying that – none. And for the traders amongst us, its a great Type 2 speculation!

    But the best time to purchase gold – as a Type Zero asset (therefore physical delivery) – is not now, in the midst of a bull phase and a possible monetary chaotic change, but before hand, when NO ONE wanted it. Not when everyone wants it.

    That has never been different!

    • Prince — Great comment. I like your classification of the three types of assets.

      The background to writing about gold in this post is that here in the US, it is being very aggressively marketed to retail investors by popular TV commentators such as Glen Beck, etc.

      Needless to say, I am pretty certain that many of the non-professionals buying it have absolutely no conception of how volatile gold is or what the risks are.

      As you say, the best time to buy gold (or any other asset) is not right in the middle of a huge bull market, but at the very time when nobody wants it.

      Again from Warren Buffet!

      “Be fearful when others are greedy and greedy when others are fearful.”

      • Didn’t I see you two blowhards sneak in the side entrance of the ‘hard assets’ conference with Michael Pascoe the other day?

      • “…the best time to buy gold (or any other asset) is not right in the middle of a huge bull market, but at the very time when nobody wants it.”

        Are you sure about this? The rate of return is the slope of the line, so you want to jump on when this line is steepest. The time when nobody wants it is that long flat bottom where your return consists of the cost of storage. Of course buying into a parabolic rally is highly risky, but therein lies the chance at reward I should think.

        • dunkelblau – I don’t disagree with you, but you’re looking at it from a trader’s perspective, and I’m simply saying that if you’re a long-term investor as opposed to a trader, there are reasons to be cautious about gold right now.

          If you’d bought gold a decade ago when nobody was interested in it, you obviously would have made a killing.

      • Yes it does Steven, and its this same imputed rent “value” that is added to the national household accounts, which is then used by learned experts to artificially reduce the median household income to price ratio (plus they include how much super you are getting and how much your employer pays for your Workcover…..) so they can p$ss down our leg whilst explaining its just raining (at 4.4 times….not 7 to 9)

        It is then used as a ridiculous excuse to say that housing construction is a productive use of capital!

        Its not – productive implies placing your scarce capital into investments that produce an inflation adjusted return.

        Neither gold or property does that and placing funds into either on the hope that there is capital gains in the future is speculative.

        As I’ve stated before, I think gold may have a future as part of a new currency/SDR etc, because we need to change our monetary/economic system to one that is not debt based and is sustainable.

        But that is speculation – not a certainty.

  2. > For a decade now, gold prices have far outpaced inflation. In fact, over the past five years, gold has delivered an annualized return of around 23%.

    This is only true if you believe government statistics on inflation i.e. the heavily manipulated CPI statistics.

    If you source your inflation statistics from more realistic providers e.g. then gold’s rise doesn’t seem so extraordinary.

    • Not to get in a side debate about the official inflation statistics, but the “real” rate of inflation is nowhere near 23%, however you measure it.

  3. Firstly, Gold is an honest store of wealth and value. It is the fiat paper money that is declining in value.

    Golds paper price may eventually be included in a basket of commodity backed SDRs(non convertible)so the future ceiling could be the new floor in price.

    Gold is money and should be seen as a currency that cannot be tinkered with by profligate governments and bankers on a power trip.

    Anyway, love the new superblog.

  4. I think you’re right about houses and gold both being a speculation, house prices near the end of their run and gold midway through. I believe house prices will come down as we start to deleverage in Australia, gold will too at some point, but i believe the floor in gold will be alot higher than in the past only if it is REMONETISED.

    As i understand it, in the 1980s 20% of world financial assets were in gold & silver at the peak in prices, currently it’s about 0.5% of world financial assets, so as you say, there is potential for more upside.

    I think the difference now is we are at a point in history where we are transitioning from a petrodollar monetary standard, to something new. What it will be I do not know. SDRs are being pushed, but who’s to say what will come. If we look at the history of money back to roman times, every fiat currency has collapsed. So if we look at gold as an inflation hedge for speculation, then I think you are right, the price could collapse some day like in the 1980s, but if you look at gold (especially as an american) as something that will still hold some value, when unwanted US dollars come flooding back into the states, then this will be an inflation hedge against a hyperinflation, not the everyday inflation we are used to.

    If you hold gold as a hedge against political crisis event, I think it has value. If you’re holding gold just to make a few bucks, then you’re correct, you’re better to but it when it way under valued. As to a political crisis, I don’t think this scenario is unreasonable. Seems to come along every 50 years or so.

    Love the blog you guys have put together. Its wonderful to read some real commentary.



    • Canga — Cheers, thanks for reading. I certainly can’t deny that gold might play some sort of role in a future monetary system, although (as I’ve argued on this blog before) I think it’s pretty unlikely that we’ll ever return to a true gold standard.

      • You’re right I don’t see a return to a gold standard in the 1970s sense, western govts don’t have the fiscal discipline to maintain this. Also, if a fixed price is applied that does not represent market value (too low in price), those countries would get drained of their gold just like in the past.

        I could envisage a currency gold backing similar to the way the euro was designed. That is, a fixed amount of gold backs the currency and it is revalued each quarter. So as they print money and prices of things (including gold) goes up, they revalue the gold backing of their currency each quarter and hopefully gold would maintain a similar ratio in $euro value relative to the money supply. That’s how I would see this working going forwards. That way gold would still trade freely, it would just go high and stay there.

        It seems to me that to maintain purchasing power parity with fiat dollars/euro/whatever as we have now, you can do this without inflation while the govt prints money so long as the total quantity of goods and services in the world grows proportionately to the money supply. That’s why a fixed gold standard was deflationary. The money supply (gold) grew slowly, but G&S grew much faster due to technology gains & cheap energy. Conversely as the emerging world competes for energy, higher energy prices are going to reduce the rates of growth (in the west) we’ve become accustomed to, which means we cannot in the west keep printing money and not expect inflation as we don’t have the productivity (ie the increase in G&S) from cheap energy to maintain this parity. So more money competing for the same stuff just pushes up prices and peak oil just makes this worse.

        That’s not to say that there isn’t a hell of alot of leveraged speculation in all these markets and for sure another bust is coming, but I think the trend is there, we will see alot of volatility and this will be the theme for the next decade.

        I think of it this way, if you have US dollars or Euro, where do you put this money, where do you run to? Equities are over valued on a PE basis, govt bonds probably will fail at some point and are giving negative real returns currently. Commodities are over valued relative to recent times, but it does seem to be where people want to stick their money. For a while anyway…

        • I just emailed through some content that perhaps could be used at the basis for an article concerning the derivatives exposure of aussie banks. Be great if one of you guys could take a look at this as a topic for discussion. There’s alot of data around this, but it doesn’t seem to get discussed anywhere.

          • Cheers. Sounds interesting. I’m focusing on US/global macro stuff these days, but one of our guys in Australia may take a look.

  5. On Warren Buffet: watch what they do not what they say. Buffet bought a vast amount of silver years ago. Also demonishes derivatives whilst actively engaging in them. Toxic assets for govt handouts. Creamed off bets on financials that were resupplied by govt (taxpayer) money. Two faced old rogue.

    Warren speculates as well as he is an investor. A covert speculator.

    Gold: Gold is anti-debt. Debt is not money. Currency is a debt instrument. Gold is the fiduciary media par excellence. Ask Glen Stevens why he has 80 tonnes of shiny door stops, or the most demanding wife in Australia.

    In times of crisis, to BOT (Balance of Trade) or not to BOT.
    Its the jimmy bar that pries the fat arsed wombats off the dunny to get the system flowing again.

  6. I can see you are having a go at the Gold spruikers which may be fair enough -however I would also flag that all the commentators/speculators I read in regards to Gold accept the boom will likely get out of control and you will want to exit.

    • Jeremy – There are some good charts here:

      Basically it’s the same story. For more than a century Australian house prices were relatively stable, before a massive boom that begins in the mid 1990s.

      It doesn’t seem to matter where you look in the world — the evidence is that over the long term you can’t expect house prices to grow much faster than inflation.

  7. Seems to me that the gold buying is rational, when outstanding debt ie money cannot be payed back its safe to say that the debt or money will have to be revalued in the future. You can have an average house at 1 miillion, petrol at $3 a litre, weekly shopping at 2 grand and gold at who knows. I dont think deflation is possible it would wipe the banks and debtors off the map. It would be nice to see the greedy azzholes take 1 to the head tho.

  8. I disagree on one point.
    There is something immoral about speculation. Speculation is gambling and gambling is by no means a respectable way to earn an income, as is order for you to “win” someone else has to “lose”

    • I’d say it’s only immoral if you’re betting against people that don’t know they’re gambling i.e. FHB’s who think property prices only go one way. Taking a position on gold and getting it wrong is no one’s fault but your own..

    • Someone or something always “loses” when wealth is “created”. Most people don’t have a problem with that because the loser is often the environment, or poor people.

  9. Note that the central banks of China, India and Russia (three large growing economies) have been purchasing much gold the last five years and storing it in anticipation of a US dollar devaluation.

    Also note that the International Monetary Fund and the World Bank (the two privately-owned financial arms of the UN) have announced several times that they would like to the US dollar to be replaced by a global currency. The Bank of International Settlements and it’s Financial Stability Board are in agreement. That pretty much means the world’s most powerful financial institutions have the US dollar in their crosshairs. Something your analysis forgot to include.

    If you are not in precious metals, and the US dollar is in a slow-motion collapse, where are you going to put your money? What if the US dollar pulls an Argentina-style overnight devaluation to the tune of 60% or 80%? How are you going to hedge (insure) your portfolio against that very high possibility?

    It’s all about collecting valuable information and hedging risk. Ignoring the information and the risk is not a wise thing to do with one’s retirement portfolio.

    • Tom – A couple of points. You’re right that these institutions have raised the possibility of using SDRs or some other alternative to the dollar but it’s very difficult to see this happening any time soon.

      As for an Argentina style 60-80% devaluation of the dollar, how can you say this is a “very high possibility”?

      Hedging risk is important, as you say. I’m just making the point that while gold is a pretty good inflation/disaster scenario hedge, it’s also a highly risky and speculative investment.

      • Highly risky and speculative as compared to what? Cash? Real estate? Stocks? Bonds? What else is there? They are all speculative and highly risky, especially when central banks routinely manipulate the markets. To say such a thing is a non-statement.

        • Tom – Look at the long-term charts of gold above and you can see what a volatile asset class it is. There is a history of massive booms and busts.

          But I suspect we will have to agree to disagree. In the end your premise is based on a doomsday scenario that I just don’t think is going to eventuate.

      • I say an Argentina-style devaluation is a high possibility since our fundamentals are far worse than their’s was when it happened.

        Not counting the passionate Fabian socialist agenda to crash the economy so it can be replaced with a UN Agenda 21.

  10. I’m just an average guy. I read financial and economic sites every day and don’t understand half of what I read.

    But, it seems to me, the gold situation is pretty straightforward. The government, through the Federal Reserve, creates money out of thin air. Are they ever going to stop doing this? No.

    The value of gold isn’t really going up, the value of the dollar is going down. This will continue until the dollar crashes.

    Everything you wrote about gold is not germane to this obvious, overriding fact.

    • ballyfager, you’re right on the money (HEH). precious metals are not investments they are money. thats it. the end. move on.

      the big difference is that this type of money cant be printed and/or devalued. now you can listen to bankers and the high priests (central bankers) if you want but of course when everything goes to hell wheres the accountability. they can be telling you gold is a lump all day long but when the dollar goes to zero (its lost 93% of its purchasing power since 1913 when the fed was created; anyone want to argue this point?) are they going to give you your purchasing power back? no. they wont even give you a “please forgive me letter”

      so no, no thanks, you keep your paper i keep my metal. THE LOONEY WENT UP AGAINST THE DOLLAR! THE POUND WENT UP AGAINST THE YEN! YADDA YADDA YADDA YADDA ENDLESSLY. guess what the central banks can do what they deem necessary for whatever reasons they see fit and they can take down your savings with them.

      me, i have never been too big on faith. you laugh all you want i’ll be in the backyard digging holes for ma stash