GLD vs. SLV vs. Aluminum Foil

Are GLD and SLV good long-term inflation hedges?

Let's start with three assumptions.

1. The price of gold and silver will keep up with inflation long-term. This has been somewhat true for gold and not so true for silver. Think modern mining equipment.

2. Your capital gains tax bracket when you sell gold and silver at some point in the future will be 28%. This might be fairly generous, if our country raises taxes at some point.

3. Inflation will average 10%. I'm not picking 10% because I am predicting it, instead it is simply a number that can inflict serious pain (which is probably why you'd be thinking about owning gold and silver in the first place).

Let's say you are 25 years old and are worried about the next 50 years. You buy GLD and SLV as hedges against inflation. Let's do some crude back of envelope calculations to see how well you can expect to do.

GLD has an expense ratio of 0.4%. SLV has an expense ratio of 0.5%. This might not matter much in the short-term, but over the long-term it will start to compound.

GLD: 0.996^50 = 0.818. Roughly 18.2% of the gold was syphoned off to pay management fees.

SLV: 0.995^50 = 0.778. Roughly 22.2% of the silver was syphoned off to pay management fees.

Okay, you are clearly underwater. Your pain isn't over yet though. You've had capital gains over the 50 years and when you sell you'll also have to pay taxes.

50 years of 10% inflation would mean that the price rose by roughly 100 times what you paid for it (1.1^50). For all intents and purposes, the entire amount is subject to capital gains tax. 28% of the gold and/or silver would therefore be syphoned off to pay taxes.

Let's see how much is left.

GLD: 0.818 * 0.72 = 0.589. 41.1% of the gold was lost to management fees and taxes.

SLV: 0.778 * 0.72 = 0.560. 44.0% of the silver was lost to management fees and taxes.

Clearly these are not good inflation hedges long-term based on my starting assumptions. It's going to take one more assumption in order to do that.

4. You buy GLD and SLV when they are at least 40% undervalued.

Gold and silver have skyrocketed in price over the last 10 years. I can't flip on the TV without seeing an advertisement about gold (either trying to buy it from me or sell it to me). It is possible that these metals are still 40% undervalued long-term, but it is also possible that they are fairly valued, or worse actually overvalued.

That brings me to aluminum foil as an inflation hedge. Let's do the same math on it. That math is much, much easier and only requires one assumption.

1. The price of aluminum foil keeps up with inflation long-term.

If you buy all the aluminum foil you will ever need today none of it will be syphoned off to pay management fees. If you don't ever resell it and instead use it solely for personal use then you also won't ever have to pay capital gains taxes. Therefore, our one and only assumption means aluminum foil will keep up with inflation long-term.

The same can be said of toilet paper to a point. I'm not quite sure how long it can be expected to last. I suspect a lifetime. I figure 10 years is fairly safe. In any event, it will probably still be usable in 20 years regardless.

If you are worried about inflation long-term and also want safety, first buy the things you know you will personally need before you start buying things you think you can eventually sell to others for a profit.

Speculating on what other people might eventually pay you for what you have is not my idea of safety. Ask any real estate speculator. Land was supposed to be an excellent long-term inflation hedge. Nothing is a good inflation hedge if you end up paying too much for it though.