There is a common pitfall in establishing an expected return for gold when using historical data to test a theory empirically. Generally, more history is preferable to less, as more observations increase one’s confidence in the analysis. Capital market assumptions for long-term stock and bond returns commonly use data from 1900 or earlier.1 Replicating this for gold creates one glaring issue: for the best part of the 20th century gold prices were determined by the conversion rate established by central banks and governments. This means that gold was money, linked to the US dollar at a fixed price that was only adjusted sporadically. As such, investors were not always able to use it in practice as an inflation hedge or an equity market hedge. And in the US, citizens were barred from acquiring gold as an investment from 1933 to 1974.
For gold, while its historical performance during Gold Standard periods is an interesting reference, it is truly its market structure and behaviour post-1971 that matters most (see Appendix C).
By way of an example, to value a company and assess its expected return, one needs to apply the analysis to the business it will be rather than to the business it has been. If the two are materially different, then past is not prologue. Take Finnish company Nokia, established as a manufacturer of rubber cable and boots until the early 1990s when it morphed into one of the global leaders in the telecoms industry. Applying valuation metrics to Nokia as a boot maker in the early 1990s would have been as fallible as valuing gold in 2024 based on its performance as money during the first half of the 20th century.
