Most investors have a deep-seated belief that bonds are a
safe investment while gold is risky and volatile. If we explore this belief
with an open mind, however, we will find that gold, not bonds, offers
vastly superior wealth protection.
The 2008 financial crisis saw an unprecedented move out of
equities and into bonds as investors looked for a safe haven, one that
would protect their portfolios. Relatively few investors chose to move into
gold. This is curious because gold, unlike bonds, is an asset class that
has a negative correlation to financial assets, thus providing the greatest
diversification as well as protection from inflation and currency
This is illustrated in
Figure 1, which shows how gold has outperformed all major asset
The US government’s response to the 2008 financial
crisis was to embark on and continue with policies of extreme stimulus and
bailout packages. These policies will provide only a temporary reprieve, a
Band-Aid solution to America’s dire situation. Since the financial
crisis was caused by excess debt, issuing more debt can hardly be the cure.
The US Treasury, with help from the Federal Reserve, essentially flooded
the economy with excess dollars, driving the money supply to unparalleled
levels and inviting the very serious threat of future inflation.
In Figure 3, we see gold
offering another distinct advantage over bonds; historically, it performs
well during periods of inflation. Bonds, however, are severely hurt by
inflation, which wipes out the purchasing power of the principal balance as
well as the purchasing power of the bond yield.
When considering inflation, it is important to use
accurate, honest data.
Currently, the official Consumer Price Index (CPI) stands
at a very modest 2 percent. However, the methodology for calculating the
CPI was changed in the early 1980s. Instead of using a fixed basket of
goods that represented a certain standard of living, today’s
methodology uses substitution, hedonic adjustments and geometric weighting
to understate the CPI. John Williams of www.shadowstats.com,
calculates the CPI using the original methodology, as shown in Figure
4. From this, we can see that real inflation is already at 8.5
percent and is poised to get much worse.
The US government is also intervening to keep interest
rates artificially low by having the Federal Reserve issue new money with
which to purchase US Treasury debt. With interest rates at record lows
there is no room to maneuver, except with further quantitative easing,
which Fed Chairman Ben Bernanke has already stated he will continue to use.
This will only serve to increase the money supply and lead to higher
inflation. This policy of aggressive quantitative easing - or, to put
it bluntly, money printing - will most certainly devalue the US dollar
further, again eroding the real value of bonds and boosting the prices
of precious metals prices and other commodities.
Critics of gold as an investment will argue that the
yellow metal does not pay any interest. While it is true that gold
held in a vault does not pay interest, it also has no counterparty risk and
cannot decline to zero. Bonds are subject to credit rating downgrades
as well as defaults, as became clear in the 2008 crisis, and can become
With interest rates much lower than inflation we can see
that, in relative terms, it is bonds that are not providing any returns.
With real inflation at 8.5 percent, bonds are not a safe investment;
rather, they represent guaranteed annual losses of about 5 percent of
purchasing power. At this rate, bond principal will be halved after
14 years. Gold, however, has generated annual compounded rates of return of
Gold investors who require cash flow can simply liquidate
part of their gold gains in order to generate such cash flow. To match the
after-tax cash flow from bond interest payments, investors need only
liquidate part of their capital gain; the remaining gain would be enough to
keep the purchasing power of the principal from declining.
BMG has a comparison chart on its website that compares
bond income to a systematic withdrawal of units in BMG BullionFund, taking
tax and inflation into account. The chart is customizable to
investors’ own situations and/or expectations, and can be found at
The example in Figure 5
compares bond income to an investment in BMG BullionFund with systematic
withdrawals, assuming an investment of $1 million, a 4 percent bond yield,
an 8 percent inflation rate and a 13 percent annual appreciation of BMG
The BMG bond calculator shows the inflation-adjusted cash
flow and the inflation-adjusted principal. In the grey section under the
heading “Bond vs. BMG BullionFund/Inflation Adjusted/2008
Dollars”, we can see that the after-tax bond interest income starts
at $24,000 and reduces to $11,332 in purchasing power by the tenth year.
The bond principal balance reduces from $1 million to $472,162.
In the gold section, BMG BullionFund investor has
liquidated only part of the annual gain, but still maintained the
inflation-adjusted purchasing power of the after--tax cash flow for the
entire period. In the “Inflation-Adjusted After-Tax Income”
section, we can see that the $24,181 net cash flow was increased to $27,347
in the tenth year. BMG BullionFund nominal value increased to
$2,686,169 while the inflation-adjusted value of BMG BullionFund
holdings increased to $1,268,306.
Bond returns are so minimal at present that it has given
rise to the serious question of whether the bond sector is in a bubble and
subject to losses if interest rates rise. This is perhaps a separate
conversation, although it is common knowledge that feverish, inexplicable
buying is the cornerstone of any bubble; with the negligible interest rates
on bonds being wiped out by inflation, it is hard to understand the
While the Federal Reserve can control short-term interest
rates, when bond investors around the world lose confidence in the US
economy and its currency, bond yields will rise and bond values will fall.
In addition, there will be day-to-day inflationary losses.
Finally, it is worth noting that bonds, like equities, are
a financial instrument, someone else’s liability; a holding of
physical gold bullion is not. A bond holder gives up their money and risks
a loss of principal for a certain period of time in return for a yield. A
holder of physical bullion could lease out their gold and generate income,
but they seldom choose to do so as it is precisely the safety of preserving
wealth in real terms without risk to capital that savvy investors seek in
Given the current economic climate and the fiscally
irresponsible policies, including competitive currency devaluation, which
governments in the US and indeed around the world are implementing, it is
no wonder that investors are desperately seeking ways to protect their
As explained above, however, moving from equities into
bonds is like jumping from the frying pan into the fire. The smart
move for wealth preservation is to a physical holding of gold bullion.
President, Bullion Management Group Inc.
October 26, 2010
Nick Barisheff is President and CEO of
Bullion Management Group Inc., a bullion investment company that provides
investors with a cost-effective, convenient way to purchase and store
physical bullion. Widely recognized in North America as a bullion expert,
Barisheff is an author, speaker and financial commentator on bullion and
current market trends. For more information on Bullion Management
Group Inc., BMG BullionFund and BMG BullionBars visit: www.bmginc.ca.