Investors always try to diversify their investments and lower their risk. Gold is respected throughout the world for its value and rich history, which has been interwoven into cultures for thousands of years.
Coins containing gold appeared in cultures like India and China many thousands of years ago, and some of the first pure gold coins known to be used were found to have been struck during the reign of King Croesus of Lydia.
Throughout the centuries, people have continued to hold gold for various reasons.
Below are Eight Reasons to Own Gold Today:
1) Gold Has A History of Holding Its Value
Unlike paper currency, coins or other assets, gold has maintained its value throughout the ages. People see gold as a way to pass on and preserve their wealth from one generation to the next.
2) Weakness of the U.S. Dollar
Although the U.S. dollar is one of the world’s most important reserve currencies, when the value of the dollar falls against other currencies as it did between 1998 and 2008, this often prompts people to flock to the security of gold, which raises gold prices.
The price of gold nearly tripled between 1998 and 2008, reaching the $1,000-an-ounce milestone in early 2008 and nearly doubling between 2008 and 2012, hitting around the $1800-$1900 mark.
The decline in the U.S. dollar occurred for a number of reasons, including the country’s large budget and trade deficits and a large increase in the money supply.
Gold has historically been an excellent hedge against inflation, because its price tends to rise when the cost of living increases.
Over the past 50 years investors have seen gold prices soar and the stock market plunge during high-inflation years.
Deflation, a period in which prices decrease, business activity slows and the economy is burdened by excessive debt, has not been seen globally since the Great Depression of the 1930s. During that time, the relative purchasing power of gold soared while other prices dropped sharply.
5) Geopolitical Uncertainty
Gold retains its value not only in times of financial uncertainty, but in times of geopolitical uncertainty.
It is often called the “crisis commodity,” because people flee to its relative safety when world tensions rise; during such times, it often outperforms other investments.
For example, gold prices experienced some major price movements last year in 2018 in response to the crisis occurring in the European Union. Its price often rises the most when confidence in governments is low.
6) Supply Constraints
Much of the supply of gold in the market since the 1990’s has come from sales of gold bullion from the vaults of global central banks.
This selling by global central banks slowed greatly in 2008. At the same time, production of new gold from mines had been declining since 2000.
According to BullionVault.com, annual gold-mining output fell from 2,573 metric tons in 2000 to 2,444 metric tons in 2007 (however, according to Goldsheetlinks.com, gold saw a rebound in production with output hitting nearly 2,700 metric tons in 2011.)
It can take from five to 10 years to bring a new mine into production.
As a general rule, reduction in the supply of gold increases gold prices.
7) Increasing Demand
In previous years, increased wealth of emerging market economies boosted demand for gold. In many of these countries, gold is intertwined into the culture.
India is one of the largest gold-consuming nations in the world; it has many uses there, including jewelry. As such, the Indian wedding season in October is traditionally the time of the year that sees the highest global demand for gold (though it has taken a tumble in 2012.)
In China, where gold bars are a traditional form of saving, the demand for gold has been steadfast.
Demand for gold has also grown among investors. Many are beginning to see commodities, particularly gold, as an investment class into which funds should be allocated.
In fact, SPDR Gold Trust became one of the largest ETFs in the U.S., as well as one of the world’s largest holders of gold bullion in 2008, only four years after its inception.
8) Portfolio Diversification
The key to diversification is finding investments that are not closely correlated to one another; gold has historically had a negative correlation to stocks and other financial instruments. Recent history bears this out:
- The 1970s was great for gold, but terrible for stocks.
- The 1980s and 1990s were wonderful for stocks, but horrible for gold.
- 2008 saw stocks drop substantially as consumers migrated to gold.
Properly diversified investors combine gold with stocks and bonds in a portfolio to reduce the overall volatility and risk.
Why Gold Investors Don’t Worry About Small Drops in Gold Prices:
A 2% move in a day isn’t much. If the price fell that much every day for an extended period, then losses would quickly mount, but so far we aren’t there.
Gold prices mostly move down when the dollar gains strength. And it has been strong since January against the world’s other leading currencies such as the Japanese yen, the euro, and the British pound. When the dollar gains value, then expect gold prices to fall.
Since late January the value of the dollar index versus major currencies has risen by around 5%, according to data from the Federal Reserve Bank of St. Louis.
Over the same time period, the price of gold dropped by approximately 6%, according to data from the London Bullion Market Association supplemented with other market data.
In other words, the upward movement in the value of the dollar is overwhelmingly responsible for the price moves. This relationship usually works vice-versa as well.
When gold prices do poorly, then other investments tend to do well. For instance, over the two decades from 1980 through the year 2000 the price of bullion dropped from a high of $850 an ounce down to less than $300.
Meanwhile, the S&P 500 index rallied more than 1000%, not including dividends, according to data from Yahoo Finance. That more than a 10-fold increase.
Gold Investment: Lower Volatility is Lower Risk
Gold is still useful to own during times of market stress. That’s true even though we aren’t there now. During the 2008-2009 financial crisis, there were periods when certain securities couldn’t be sold.
An example of that is the market for auction rate auction rate securities, a type of bond. If you owned those notes during that period, then you couldn’t sell them no matter how low a price you offered.
However, the market for gold never dried up. There were always ready buyers for the metal or the futures.
It should be evident that currently, the securities markets are not stressed. Stocks are booming, and investors are happily trading bonds.
The fact that gold prices move up and down is one of its attractions for investors. Just like other investments, the price of gold changes from day to day.
However, those price movements don’t tend to correlate with the changes in the value of stocks or bonds.
When share prices drop then gold prices might move up down or remain unchanged. That lack of correlation helps to diversify a portfolio.
Better still, when looked at in combination with other investments, adding gold can reduce a portfolio’s overall volatility. For investors, risk and volatility are the same thing. Lower volatility is tantamount to lower risk.
All these points remain true despite the temporary pullbacks. If you own gold and are worried that prices may drop then think about why you purchased it in the first place.
Most veteran investors say that they own it for one of the following three reasons:
- To help with portfolio diversification or
- as a hedge against the declining value of paper money, or
- as insurance that you’ll always be able to raise cash by selling some of the metal.
What Moves the Price of Gold?
The price of gold is moved by a combination of supply, demand, and investor behavior.
That seems simple enough, yet the way those factors work together is sometimes counterintuitive.
For instance, many investors think of gold as an inflation hedge. That has some common-sense plausibility, as paper money loses value as more is printed, while the supply of gold is relatively constant.
As it happens, mining doesn’t add much year to year (so it has a relatively constant supply).
Gold Prices: Correlation to Inflation
Two economists, Claude B. Erb, of the National Bureau of Economic Research, and Campbell Harvey, a professor at Duke University’s Fuqua School of Business, have studied the price of gold in relation to several factors.
It turns out that gold doesn’t correlate well to inflation. That is, when inflation rises, it doesn’t mean that gold is necessarily a good bet.
So, if inflation isn’t driving the price, is fear? Certainly, during times of economic crisis investors flock to gold.
When the Great Recession hit, gold prices rose. But gold was already rising until the beginning of 2008, nearing $1,000 an ounce. It then fell under $800 and then bounced back rising as the stock market bottomed out.
That said, gold prices kept rising even as the economy recovered. The price of gold peaked in 2011 at $1,921, and has been on a slide ever since. It now trades around $1,300.
It also means there isn’t any underlying ‘fundamental’ to the price of gold. If investors start flocking to gold, the price rises no matter what the monetary policy might be.
That doesn’t mean that this is completely random or the result of herd behavior. There are forces that affect the supply of gold in the wider market. Also, gold is a worldwide commodity market, like oil or coffee. (For more, see: How Can I Invest in Gold?)
Unlike oil or coffee, however, gold isn’t consumed. Almost all the gold ever mined is still around.
Gold Jewelry as Investment
There is some industrial use for gold, but that hasn’t increased demand as much as jewelry or investment.
The World Gold Council’s 2017 figures show that total demand was 4,071 tons, with only 332.8 tons going to the tech sector.
The rest was investment, at 371.4 tons, jewelry, at 2,135.5 tons, bar and coin demand of 1,029.2 tons, and ETF’s et al, at 202.8 tons.
Back in 2001, Gold prices were nearing all-time lows (at least since ownership of bullion was re-legalized in the 70s). At this time, jewelry accounted for 3,009 tons, while investment was at 357 tons, and tech required 363 tons of gold.
If anything, one would expect the price of gold to drop over time, since there is more and more of it around. So, why doesn’t it?
Aside from the number of people who might want to buy it constantly on the rise, the jewelry and investment demand offer some clues.
Even though in countries like India and China gold can act as a store of value, the people who buy it there don’t regularly trade it: few will pay for a washing machine by handing over a gold bracelet.
Jewelry demand tends to rise and fall with the price of gold. When prices are high, the demand for jewelry falls relative to investor demand.
Hug says the big market movers are often central banks. In times when foreign exchange reserves are large and the economy is dragging along, a central bank will actually want to reduce the amount of gold it holds.
That’s because the gold is a dead asset – unlike bonds, or even money in a deposit account, it generates no return.
The problem for central banks is that this is precisely when the other investors out there aren’t that interested in gold.
Thus, a central bank is always on the wrong side of the trade, even though selling that gold is precisely what the bank is supposed to do. As a result, the price of gold falls.
Central banks have since tried to manage their gold sales in a cartel-like fashion, to avoid disrupting the market too much.
A document called the Washington Agreement on Gold essentially states that the banks won’t sell more than 400 metric tons in a year.
It’s not binding, as it’s not a treaty; rather, it’s more of a gentleman’s agreement. However, it is one that is mainly in the interests of central banks. This is because unloading too much gold on the market at once would negatively affect their portfolios.
One exception is China. The Chinese central bank has been a net buyer of gold, and that could be putting some upward pressure on the price. The price of gold has still fallen, though, so even Chinese buying has at most slowed the decline.
Besides central banks, exchange traded funds (ETF’s) – such as the SPDR Gold Shares (GLD) and iShares Gold Trust (IAU), which allow investors to buy into gold without buying mining stocks – are now major gold buyers and sellers.
Both offer shares in bullion, and measure their holdings in ounces of gold. The SPDR ETF currently holds approximately 9,600 ounces, while the iShares ETF has some 5,300.
Still, these ETF’s are designed to reflect the price of gold, not move it
Speaking of portfolios, Hug said a good question for investors is what the rationale for buying gold is.
As a hedge against inflation, it doesn’t work well, but seen as a piece of a portfolio, it’s a reasonable diversifier.
It’s simply important to recognize what it can and cannot do. In real terms, gold prices topped out in 1980, when the price of the metal hit nearly $2,000 per ounce (in 2014 dollars). Anyone who bought gold then has been losing money since.
On the other hand, the investors who bought it in 1983 or 2005 would be happy selling now, even with recent price drops.
It’s also worth noting that the ‘rules’ of portfolio management apply to gold as well. The total number of gold ounces one holds should fluctuate with the price. If one wants 2% of the portfolio in gold, then it’s necessary to sell when the price goes up and buy when it falls.
Retaining Value: A Golden Trait
One good thing about gold: it does retain value. Erb and Harvey compared the salary of Roman soldiers many years ago to what a modern soldier would get, based on how much those salaries would be in gold.
Roman soldiers were paid 2.31 ounces of gold per year, while centurions got 35.58 ounces. We will assume they were in existence 2,000 years ago and also assuming $1,600 per ounce. A Roman soldier would have received the equivalent of $3,704 per year, while a U.S. Army private in 2011 received $17,611. So a U.S. Army private gets about 11 ounces of gold (at current prices).
That’s an investment growth rate of about 0.08% over approximately 2,000 years,.
A centurion (roughly equivalent to a captain) got $61,730 per year, while a U.S. army captain gets $44,543 – 27.84 ounces at the $1,600 price, or 37.11 ounces at $1,200. The rate of return is –0.02% per annum – essentially zero.
The conclusion Erb and Harvey have arrived at is that the purchasing power of gold has stayed quite constant and largely unrelated to the current price.
The Bottom Line
Gold should be an important part of a diversified investment portfolio because its price increases in response to events that cause the value of paper investments, such as stocks and bonds, to decline.
Although the price of gold can be volatile in the short term, it has always maintained its value over the long term.
Through the years, it has served as a hedge against inflation and the erosion of major currencies, and thus is an investment well worth considering.
Feel free to read more about why we recommend rolling over your retirement account or investing your resources into a Gold IRA. A Gold IRA contains physical gold and/or precious metals coins or bullion in your retirement portfolio. It is our number one recommendation for investing for your retirement. (View Main Page: Best Gold IRA Options)
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