For thousands of years Gold has been a pillar of tangible, storable and transportable wealth. Gold has always been a staple of global currency, a commodity, an object of beauty and an investment. During the late 80s and 90s financial markets rapidly developed and liquidity poured into stocks and mutual funds at an alarming rate. Gold, during this economically robust period, fell out of favor as the “safe haven” or “flight to quality” asset that it was through the 70s and early 80s when it was used as an inflation hedge. In recent years there has been a major resurgence in interest and investor demand in gold as an alternative asset class to paper based investments, the failing US dollar and even Real Estate. The current price rally from Gold’s turn-of-the-century lows to its current levels has clearly awoken awareness about the shiny yellow metal. There are many reasons, both fundamental and psychological, that individuals as well as institutions around the globe are once again becoming very serious about investing in hard gold. In this column we will examine some of the more fundamental reasons investors are looking again at gold, examine the psychology of today’s market and then, based on the data, you can decide if you should convert some of your paper savings to hard Gold…
Why are investors running for Gold?
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 products available, including coins and bars, 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.
Gold and the dollar
Gold is often used as an effective hedge against fluctuations in the US dollar, the world’s main trading currency. If the dollar appreciates, the dollar gold price falls, while a fall in the dollar relative to the other main currencies produces a rise in the gold price. While this may also be true of other assets, gold has consistently proved among the most effective in protecting against dollar weakness.
Gold and Inflation:
Market cycles may come and go, but – over the long term – gold keeps its purchasing power. Its value, in terms of the real goods and services that it can buy, has remained remarkably stable. In contrast, the purchasing power of many currencies has generally declined due to the impact of rising prices for goods and services. As a result, gold is often bought to counter the effects of inflation and currency fluctuations. Investors in gold can point to a growing body of research supporting gold’s reputation as a protector of wealth against the ravages of inflation. In the short run, experience has shown that gold can deviate from its long-run inflation-hedge price.
Asset allocation is an important aspect of any investment strategy. By balancing asset classes of different correlations, investors hope to maximize returns and minimize risk. However, while many investors may believe that their portfolios are adequately diversified, they typically contain only three asset classes – stocks, bonds and cash. There are a wide range of reasons and motivations for people and institutions seeking to invest in gold. And, clearly, a positive price outlook, underpinned by expectations that the growth in demand for the precious metal will continue to outstrip that of supply, provides a solid rationale for investment. Of the other key drivers of investment demand, one common thread can be identified: all are rooted in gold’s abilities to insure against uncertainty and instability and protect against risk.