Gold vs Real Estate

A lot of investment advisors are touting gold as a hedge against a weakening economy amid global uncertainty. On the flip side, ongoing weakness in the US economy has brought down real estate prices. So what’s a better investment now – gold or real estate?

Gold Fundamentals

In an article in the Wall Street Journal on July 12, 2010 titled “Why Gold Is The Worst Investment Right Now,” James Altucher explains that gold was at roughly $800 an ounce in 1980, which works out to about $2,000 in today’s dollars adjusted for inflation. Gold currently trades at $1,752 an ounce. So, Altucher believes that over the past 32 years, gold has not even kept up with inflation and has lost about 40% of its “inflation-adjusted” value since 1980.

Moreover, as the chart above shows, gold prices have spiked in recent years, making some feel that gold is a less-than-attractive investment right now. Indeed, the recent pullback from highs earlier in the year might suggest that gold is losing its luster. Still others, ever bullish on gold, may believe that pullbacks such as this one are ideal opportunities to buy, and base their gold-investment thesis on imploding European economies, the Arab Spring, deepening tensions between Iran and Israel over nuclear weapons, economic slowdown in the emerging markets, and so on.

A July 2010 article in The Wall Street Journal (WSJ) sent gold and financial markets in a tizzy. The article was titled “Central Banks Swap Tons of Gold To Raise Cash, Surprising Market.”

It basically said that a few European central banks had borrowed close to $14 billion from the Bank for International Settlements and pawned 346 tonnes of their gold reserves as collateral. This, in effect, provided more gold for purchase and dampened gold prices back then.

On the day the WSJ article ran, China announced that it was not planning on buying more gold for its own reserves. This dashed the hopes of gold bulls who were hoping that large-scale buying by Asian central banks would move gold prices higher. And China’s announcement added to the negative repercussions from the European Central Bank’s move to pawn its gold away.

Moreover, who has money to buy gold today? Certainly not your average citizens because they’re hurting from high unemployment, a weak jobs market, weakness in housing and salary cutbacks in a globally weak economic environment – and have little extra cash to buy gold, especially at such elevated high prices. And if unemployment stays high, retail gold held by individuals and families could soon find its way into the market through pawn shops, and again move gold prices lower.

All these developments are bearish for gold which could go down sharply in the years ahead, potentially back to $1000 or less.

Warren Buffett, too, has famously commented on humankind’s bizarre obsession with gold: “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

On the flip side, gold bulls point to the weaknesses in our current fiat system of money where we just keep printing money out of thin air causing the currency in circulation to rise inexorably while our own dollar holdings get substantially depleted by inflation. The graph below, for example, shows how the dollar’s lost purchasing power over the years.

They also point to graphs like the one below that shows, in nominal terms, that gold prices have consistently risen over time.

Extreme gold bulls also see a repeat of some sort of hyper-inflation on the cards and project that this will make gold and silver shoot up in value, with predictions of gold going all the way up to $8,000/oz. What’s more, these bulls don’t see these price gains as temporary bubbles that will eventually burst but as permanent new levels based on fundamental supply and demand for gold.

But as we noted earlier, gold prices should be compared to how well they’ve done relative to inflation and whether gold truly has been a good investment choice.

Real Estate

When compared to gold or even stocks, real estate apparently came out ahead, according to a paper written by Robert Shiller of Yale University.

Shiller’s graph (above) shows a steady rise in real-estate, remarkably unperturbed by macro-economic fluctuations and stock market meltdowns such as the dot-com crash post 9/11. Where even the savviest financial investors could not escape the stock market’s wrath, real-estate investors did nothing and happily saw their assets steadily rise in value.

Also note that while stocks lost value from Mar-00 to Jun-06, real-estate climbed about 56%.

Another interesting chart (below) reaffirms the attractiveness of real-estate. The chart essentially shows that US home prices have consistently appreciated in value year-over-year. Note that for the period shown, appreciation never dipped below the 0% line, indicating continuous growth in U.S. home prices.

Over the past few years though, home prices have corrected significantly and are now back to where they were around 2002 – 2003. The surge in home prices during the dot-com millionaire boom and then again in the mid-2005 timeframe appears to now have corrected itself, with home values falling through the mortgage financial crisis of 2008-2009. Prices now appear to reflect a long-term growth trend that keeps home prices just above inflation, with about a 4% annualized gain. In this low interest rate environment, many real estate investors are also looking at rental incomes paying off monthly mortgage payments – making real estate look attractive again.

While foreclosures were at their peak a few years ago, banks have consciously worked to slow the release of their foreclosed real estate inventory to keep prices from falling even lower, and have sort of contained the free fall in home prices. Yet, even though prices have stabilized, the low interest rate environment makes this a good time to buy.

That said, a double-dip recession or some extraordinary black swan event could rock the US economy sizably. In fact, many top economists foresee a lot of bad in the years ahead and are cautioning investors to not get lulled into thinking the worst is behind us. They warn of a very severe storm waiting off our shores.

Real estate investors that want to hold for the long run will weather any storm that may come ashore – simply because all relevant economic, individual freedom and demographic metrics point to the US still being the # 1 destination for creative minds and hard-working people from all over the world. So, over the long run, someone will likely look back and say, “why didn’t I buy more real estate back then when it was really cheap??

When normalcy returns and people do not fear for their jobs as much as they do now, one of the first things they’d want to do is buy a house. And that demand will result in rising home prices.

While gold has no utility, as Buffett says, housing and real-estate are irreplaceable in our lives because they have tremendous utility.

Summary

So which one’s really better – gold or real estate? The answer unfortunately is not crystal clear – it all depends on how you like to build and manage your portfolio and the kinds of risks you’re willing to take. If things don’t get much worse, gold could fall 50% in value over the coming years while home prices could hold up or even rise. But if an economic storm hits us, gold could shoot higher and real estate could fall 50%. But real estate gives you utility, it gives you rental income, can be bought using a mortgage and does not directly burn a hole in your pocket as gold does… so you decide, who do you want to marry?