Over the past three years, gold has delivered a total return of 75%, versus 41% for the S&P 500.
Remarkably, gold is now even outperforming the S&P 500 Index over the past 20 years, with an annualized rate of return of approximately 10.7%, versus 10.3% for the S&P 500.
Can it continue?
Investment success is a double-edged sword. On the one hand, it is evidence of a superior asset. On the other hand, extremely strong performance can signal overvaluation (or even a bubble).
When a stock does extremely well over a long time frame, this generally means the company has consistently surpassed growth expectations. This very often indicates a good business.
But businesses are dynamic. They are constantly growing and evolving. Successful ones generate more and more cash as time passes, which makes these businesses inherently more valuable.
Gold, on the other hand, literally does not change. That is in fact a large part of what makes gold so valuable. It is chemically inert.
One of the reasons gold has for millennia functioned so well as a store of value is that it does not rust or otherwise decay.
Gold is also scarce and difficult to mine. The total supply of gold only grows about 1% to 2% per year, much slower than other commodities.
The only thing that has really changed about gold this year, or over the past 20 years for that matter, is that the total above-ground supply of it has slightly grown.
The price of gold has changed, however. Not because gold has changed—but because the world has changed.
Gold’s rise
Gold can only be understood in relation to the currency in which it is priced. For American investors, what matters is the price of gold in U.S. dollars.
The relationship between the supply of U.S. dollars to the supply of gold is therefore important to understanding the gold price. But this is mainly because the U.S. is the largest economy in the world (representing around 26% of global GDP).
Gold is a global commodity. So it is not just the supply of U.S. dollars that creates demand for gold. The fiat money that is printed by all countries feeds into demand for gold.
The relationship between the U.S. money supply and gold is worth examining, however, because growth in the U.S. money supply is a good reflection of the growth in global money.
Economists have various tools to measure the U.S. money supply. The commonly used metric known as M2 captures physical cash as well as funds held in savings and money market accounts (which can be easily converted into cash).
Since 1980, the U.S. has printed a lot of money. M2 has grown from less than $2 trillion to more than $22 trillion. The compound annual growth rate of M2 has been over 6%.
