Investing in Gold and its Pros and Cons

Gold is more than just another commodity, it’s a currency. It is the currency that evolved in the marketplace over the last 5,000 years.

Gold was the main currency in most of Europe, Asia and the Americas for most of the last few thousand years, up until 1971. Silver was also widely used, though to a lesser extent.

Gold evolved independently as money in the world’s main civilizations, because it is:

  1. Rare.  About 5 parts per billion of the earth’s crust. Difficult and expensive to mine.
  2. Indestructible.  It does not tarnish or decay.
  3. Compact. If all the gold ever mined were made into a solid block whose base was the size of a football field, then it would be about 1.5 meters (5 feet) high.
  4. Malleable and divisible. You can easily reshape it, flatten it, and divide it into tiny pieces.
  5. Hard to find. The amount of mined gold has increased only slowly, rarely more than 2% per year.

Why Invest in Gold?

If you’re looking to store wealth in something both rare and secure today, you will find nothing to match gold.

Gold always tends to reward cautious savers in times of financial stress, because it is both hard to destroy and tightly supplied.

In short, it is the very opposite of debt.

Gold doesn’t corrode or tarnish, and it’s relatively useless to industry. That’s why almost all of the entire stock of gold mined over the last 4,000 years remains unused today. It exists as either jewelry or bullion, both of which act to store wealth and value.

Of all the precious metals, gold is the most popular as an investment. Investors generally buy gold as a hedge or safe haven against any economic, political, social or currency-based crises. These crises include investment market declines, burgeoning national debt, currency failure, inflation, war and social unrest. Investors also buy gold early in a bull market and aim to sell it before a bear market begins, in an attempt to gain financially.

Historically, gold has been a proven method of preserving value when a national currency was losing value. If your investments are valued in a depreciating currency, allocating a portion to gold assets is similar to a financial insurance policy. In the past year, the climb in the price of gold above $800 per ounce is due to many factors, one being that the dollar is losing value.

Safe containing gold bars and coins for thousands of years, gold has been valued as a global currency, a commodity, an investment and simply an object of beauty. As financial markets developed rapidly during the 1980s and 1990s, gold receded into the background and many investors lost touch with this asset of last resort. Recent years have seen a striking increase in investor interest in gold. While a sustained price rally, underpinned by the fact that demand consistently outstrips supply, is clearly a positive factor in this resurgence, there are many reasons why people and institutions around the world are once again investing in gold.

Gold vs. Paper-Money Inflation

New gold is being found and mined today at the rate of some 2,600 tonnes per annum.

That’s a modest increase of 1.6% per year to the above-ground supply. And critically for the value of gold, this annual growth-rate lies beyond the power of politicians or investment banks to increase.

The supply of Euros, in contrast — the most hawkishly-managed major world currency right now — is currently expanding by 11.5% per year.

Thanks to this tight supply, gold grew its purchasing power more than nine times over during the 1970s — the last worldwide surge in inflation. In terms of business assets, it rose 23 times over by the start of 1980 as measured against the Dow Jones Industrial Average.

During the financial collapse of the 1930s — but this time amid a deflation caused by half of all banks in the United States failing — gold bought 17 times as many financial assets as it did before the Great Crash of 1929.

Now debt defaults and inflation are working together today, forcing a fresh crisis in the value of money. Gold has already risen three-fold against the New York stock market since early 2000. It’s recently turned higher in terms of residential and commercial real estate, too.

Time to Buy Gold?

Gold doesn’t care whether a financial collapse destroys the value of money (inflation) or the value of debt (deflation). Its unique characteristics — indestructibility and tight supply — mean its owners can thrive amid either.

But that doesn’t make gold a “forever” investment. Gold will always lose value during stable periods of strong economic growth.

Over the twenty years to 2000, for example, gold lost 95% of its value in terms of US real estate. So it’s no surprise that, as a proportion of world investment portfolios, gold fell from around 2% to effectively zero.

The trend in gold prices finally turned higher at the start of this decade, just as Gordon Brown — now the British prime minister — sold half the UK’s national gold reserves at less than $300 an ounce.

Since then gold has trebled and more. But this gain remains small in the context of previous gold trends. It’s also been limited by Western governments persuading their citizens that “core” inflation in the cost of living is running at just 2% per year or below.

Gold and Risk

Financial instruments usually carry three main types of risk.

  1. Credit risk: the risk that a debtor will not pay
  2. Liquidity risk: the risk that the asset cannot be sold as a buyer cannot be found.
  3. Market risk: the risk that the price will fall due to a change in market conditions.

Gold is unique in that it does not carry a credit risk. Gold is no one’s liability. There is no risk that a coupon or a redemption payment will not be made, as for a bond, or that a company will go out of business, as for an equity. And unlike a currency, the value of gold cannot be affected by the economic policies of the issuing country or undermined by inflation in that country. At the same time, 24-hour trading, a wide range of buyers – from the jewelry sector to financial institutions to manufacturers of industrial products – and the wide range of investment channels available, including coins and bars, jewelry, futures and options, exchange-traded funds, certificates and structured products, make liquidity risk very low. The gold market is deep and liquid, as demonstrated by the fact that gold can be traded at narrower spreads and more rapidly than many competing diversifiers or even mainstream investments.

Reasons to say NO to Gold

  • Gold doesn’t pay income or interest.
  • Except for the last five years, gold has been in a bear market after a peak in 1980.
  • Central banks have tons of bullion which they occasionally threaten to sell.
  • If you don’t count the last five years, gold stocks have not done well.
  • Since gold funds have made big moves over the past five years, it’s time for them to drop back.
  • Your broker probably won’t recommend gold funds.

Reasons to say YES to Gold

  • The dollar is weak and getting weaker due to national economic policies which don’t appear to have an end.
  • Gold price appreciation makes up for lost interest, especially in a bull market.
  • The last four years are the beginning of a major bull move similar to the 70’s when gold moved from $38 to over $800.
  • Central banks in several countries have stated their intent to increase their gold holdings instead of selling.
  • All gold funds are in a long term uptrend with bullion, most recently setting new all-time highs.
  • The trend of commodity prices to increase is relative to gold price increases.
  • Worldwide gold production is not matching consumption. The price will go up with demand.
  • Most gold consumption is done in India and China and their demand is increasing with their increase in national wealth.
  • Several gold funds reached all-time highs in 2007 and are still trending upward.
  • The short position held by hedged gold funds is being methodically reduced.
  • U.S. government economic policies over the past decade have systematically projected the U.S. economy down a road with uncontrollable federal spending and an uncontrollably increasing trade deficits. Both will cause the dollar to lose in international value and will increase the price of alternative investments, such as gold.
  • With the recent devaluation of many international currencies, the U.S. dollar was the international safe haven of last resort. We are seeing signs of this ending due to many financial factors, the most important one being a falling dollar.
  • There are over One Trillion dollars ($1,500,000,000,000) of U.S. debt owned by foreigners which could be repatriated under certain conditions. This could cause a major decline in the value of the dollar and a soaring gold price.
  • If you believe in ‘buy low, sell high’, gold is still low, but climbing.

Assessing Your Options

One’s motivation for investing in gold is fundamental to deciding how to invest. Are you a speculator, investor or saver? Do you wish to take a short term speculative position in gold? Are you investing for the short, medium or long term? Or are you diversifying; saving or using gold as a form of financial insurance (gold’s primary role)?

When assessing one’s gold investment options one must decide what one’s motivation is. Once this is done, the primary considerations which should be looked at are the costs (both upfront and possibly recurring annual fees), proximity to your asset and perhaps most importantly today counter party risk.

Conclusion

Experienced and knowledgeable investors have long known that gold and gold related investments can be solid investment choices. Gold is stable in times of global geopolitical instability and when there is economic uncertainty, recessions and depressions. It is important that investors look at their portfolios holistically. Used correctly, gold and gold related investments can be highly effective components of a properly diversified investment portfolio.

sources: invest.gold.org, eaglewing.com, gold-eagle.com, moneyweek.com, photo from freedigitalphotos.net

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