As the spot price of gold topped $1,200 per ounce recently, gold bugs gushed about the potential for the price to rise above $2,000 or even $3,000 per ounce. Given the prevalence of stories about gold in the financial press, we feel now is a good time to discuss what gold is, what it is not, and how it should be used in a portfolio.

We all know that gold is a precious metal that has been used for centuries as a store of value and as a material for making jewelry. We also know that gold coins are minted by sovereign nations around the globe and that futures contracts on the price of gold are traded on various commodities exchanges.

However, it is probably more informative to discuss what gold is not. Investopedia defines “investment” in the economic sense as, “(a) purchase of goods that are not consumed today but are used in the future to create wealth.”  Stocks and corporate bonds fit this definition because they provide corporations with cash that they can use to grow their businesses and create wealth. Gold, however, does not fit this definition. Gold is not an investment because it does not create wealth; it is merely a piece of metal that is used to store value or accessorize an outfit. And since gold does not create wealth, it should not be expected to provide a return higher than the long-term rate of inflation.

The fact that long-term returns on gold generally do replicate the long-term rate of inflation has led many to conclude that gold can be used as an effective inflation hedge. Unfortunately, the real story is more complicated than this. While gold is certainly a good inflation hedge over very long periods of time, the price of gold is far too volatile for gold to be an effective inflation hedge in the short or intermediate-term. In 2008, the price of gold fell by nearly 28% from its peak before rallying more than 35% to new highs this calendar year. This high level of volatility makes gold an inappropriate short-term hedge for consumer inflation, which tends to rise and fall by only a few percentage points each year.

Heritage gains exposure to the price of gold via our commodity fund. We believe that gold, along with other precious and industrial metals, energy commodities and agricultural commodities, provides an effective hedge against long-term increases in inflation. We also believe that the use of gold for any purpose other than as a long-term inflation hedge or as a piece of jewelry is pure speculation, and not worthy of the term “investment.”

We hope you are enjoying the holiday season, and as always, we welcome your questions, comments and suggestions for future topics.