Commodities

Does it Still Pay to Invest in Gold?

From gold exchange-traded funds (ETFs) to gold stocks to buying physical gold, investors now have several different options when it comes to investing in the royal metal. But what exactly is the purpose of gold? And why should investors even bother investing in the gold market? Indeed, these two questions have divided gold investors for the last several decades. One school of thought argues that gold is simply a barbaric relic that no longer holds the monitory qualities of the past. In a modern economic environment, where paper currency is the money of choice, gold’s only benefit is the fact that it is a material that is used in jewelry.

On the other end of the spectrum is a school of thought that asserts gold is an asset with various intrinsic qualities that make it unique and necessary for investors to hold in their portfolios. In this article, we will focus on the purpose of gold in the modern era, why it still belongs in investors’ portfolios and the different ways that a person can invest in the gold market.

A Brief History on Gold
In order to fully understand the purpose of gold, one must look back at the start of the gold market. While gold’s history began in 3000 B.C, when the ancient Egyptians started forming jewelry, it wasn’t until 560 B.C. that gold started to act as a currency. At that time, merchants wanted to create a standardized and easily transferable form of money that would simplify trade. Because gold jewelry was already widely accepted and recognized throughout various corners of the earth, the creation of a gold coin stamped with a seal seemed to be the answer.

Following the advent of gold as money, gold’s importance continued to grow. History has examples of gold’s influence in various empires, like the Greek and Roman empires. Great Britain developed its own metals based currency in 1066. The British pound (symbolizing a pound of sterling silver), shillings and pence were all based on the amount of gold (or silver) that it represented. Eventually, gold symbolized wealth throughout Europe, Asia, Africa and the Americas.

The United States government continued on with this gold tradition by establishing a bimetallic standard in 1792. The bimetallic standard simply stated that every monetary unit in the United States had to be backed by either gold or silver. For example, one U.S. dollar was the equivalent of 24.75 grains of gold. In other words, the coins that were used as money simply represented the gold (or silver) that was presently deposited at the bank.

But this gold standard did not last forever. During the 1900s, there were several key events that eventually led to the transition of gold out of the monetary system. In 1913, the Federal Reserve was created and started issuing promissory notes (the present day version of our paper money) that guaranteed the notes could be redeemed in gold on demand. The Gold Reserve Act of 1934 gave the U.S. government title to all the gold coins in circulation and put an end to the minting of any new gold coins. In short, this act began establishing the idea that gold or gold coins were no longer necessary in serving as money. The United States abandoned the gold standard in 1971 when the U.S.currency ceased to be backed by gold.

The Importance of Gold In the Modern Economy
Given the fact that gold no longer backs the U.S. dollar (or other worldwide currencies for that matter) why is it still important today? The simple answer is that while gold is no longer in the forefront of everyday transactions, it is still important in the global economy. To validate this point, one need only to look as far as the reserve balance sheets of central banks and other financial organizations, such as the International Monetary Fund. Presently, these organizations are responsible for holding approximately one-fifth of the world’s supply of above-ground gold. In addition, several central banks have focused their efforts on adding to their present gold reserves.

Gold Preserves Wealth
The reasons for gold’s importance in the modern economy centers on the fact that it has successfully preserved wealth throughout thousands of generations. The same, however, cannot be said about paper denominated currencies. To put things into perspective, consider the following example.

Example – Gold, Cash and Inflation
In the early 1970s, one ounce of gold equaled $35. Let’s say that at that time, you had a choice of either holding an ounce of gold or simply keeping the $35. Both would buy you the same things at that, like a brand new business suit, for example. If you had an ounce of gold today and converted it for today’s prices, it would still be enough to buy a brand new suit. The same, however, could not be said for the $35. In short, you would have lost a substantial amount of your wealth if you decided to hold the $35 and you would have preserved it if you decided to hold on to the one ounce of gold because the value of gold has increased, while the value of a dollar has been eroded by inflation.

Gold as a Hedge Against a Declining U.S. Dollar and Rising Inflation
The idea that gold preserves wealth is even more important in an economic environment where investors are faced with a declining U.S. dollar and rising inflation (due to rising commodity prices). Historically, gold has served as a hedge against both of these scenarios. With rising inflation, gold typically appreciates. When investors realize that their money is losing value, they will start positioning their investments in a hard asset that has traditionally maintained its value. The 1970s present a prime example of rising gold prices in the midst of rising inflation

The reason gold benefits from a declining U.S. dollar is because gold is priced in U.S. dollars globally. There are two reasons for this relationship. First, investors who are looking at buying gold (like central banks) must sell their U.S. dollars to make this transaction. This ultimately drives the U.S. dollar lower as global investors seek to diversify out of the dollar. The second reason has to do with the fact that a weakening dollar makes gold cheaper for investors who hold other currencies. This results in greater demand from investors who hold currencies that have appreciated relative to the U.S. dollar.

Gold as a Safe Haven
Whether it is the tensions in the Middle East, Africa or elsewhere, it is becoming increasingly obvious that political and economic uncertainty is another reality of our modern economic environment. For this reason, investors typically look at gold as a safe haven during times of political and economic uncertainty. Why is this? Well, history is full of collapsing empires, political coups, and the collapse of currencies. During such times, investors who held onto gold were able to successfully protect their wealth and, in some cases, even use gold to escape from all of the turmoil. Consequently, whenever there are news events that hint at some type of uncertainty, investors will often buy gold as a safe haven.

Gold as a Diversifying Investment
The sum of all the above reasons to own gold is that gold is a diversifying investment. Regardless of whether you are worried about inflation, a declining U.S. dollar, or even protecting your wealth, it is clear that gold has historically served as an investment that can add a diversifying component to your portfolio. At the end of the day, if your focus is simply diversification, gold is not correlated to stocks, bonds and real estate.

Different Ways of Owning Gold
One of the main differences between investing in gold several hundred years ago and investing in gold today is that there are many more options to participating in the intrinsic qualities that gold offers. Today, investors can invest in gold by buying:

Gold Futures

Gold Coins

Gold Companies

Gold ETFs

Gold Mutual Funds

Gold Bullion

Gold Jewelry

In Summary
There are advantages to every investment. If you are more concerned with holding the physical gold, buying shares in a gold mining company might not be the answer. Instead, you might want to consider investing in gold coins, gold bullion, or jewelry. If your primary interest is in using leverage to profit from rising gold prices, the futures market might be your answer.

Emanuel Balarie can be contacted at Balarie Capital

Emanuel Balarie is the Managing Director of Balarie Capital Management and is also the co founder and CEO of FundSeeder which is an online platform for traders.

He is also the author of "Commodities for Every Portfolio: How You Can Profit From the Long-Term Commodity Boom" published by Wiley in 2007

Emanuel Balarie is the Managing Director of Balarie Capital Management and is also the co founder and CEO of FundSeeder which is an online platform fo...

PtCalc

Newbie
3 0
Investment Performance and Return on Investment

Good overview of history.

Here is a link on Investment Performance and Return on Investment of precious metals:
http://www.ptcalc.com/precious-metal-investment-performance.php

Past performance would say yes, however, past performance does not imply future returns.
 

Atilla

Legendary member
18,848 2,636
Article is on the money and pretty much covers all the main points well.

Few points from my perspective; the one school of thought arguing gold is simply a barbaric relic that no longer holds the monitory qualities of the past is one that should be promptly discarded in to room 101. Really, how old is this school and what do they base their evidence on? Last couple of years I'd guess.

Secondly, reason why Nixon took the US off the gold standard was precisely because of the Vietnam war which was costing it more than just lives. Moreover, the recent Iraq war clearly showed the US and the dollar standard is VERY vulnerable no matter what the hype is. Don't be fooled by analysts would be my advice.

Countries can't go to war and simply get what they want by printing money. There is always a pay back.

Iran was also able to conduct international trade by using gold instead of dollars as the US applied economic sanctions. This is proof many other countries are happy to accept gold instead of dollars. Transaction costs may have been a little higher but trade continued.


Gold is here to stay and I'm sure for many more years to come. Perhaps for another few millenniums until man gets off this planet and finds another. (y)
 

MajorMagnuM

Legendary member
9,284 887
Article is on the money and pretty much covers all the main points well.

Few points from my perspective; the one school of thought arguing gold is simply a barbaric relic that no longer holds the monitory qualities of the past is one that should be promptly discarded in to room 101. Really, how old is this school and what do they base their evidence on? Last couple of years I'd guess.

Secondly, reason why Nixon took the US off the gold standard was precisely because of the Vietnam war which was costing it more than just lives. Moreover, the recent Iraq war clearly showed the US and the dollar standard is VERY vulnerable no matter what the hype is. Don't be fooled by analysts would be my advice.

Countries can't go to war and simply get what they want by printing money. There is always a pay back.

Iran was also able to conduct international trade by using gold instead of dollars as the US applied economic sanctions. This is proof many other countries are happy to accept gold instead of dollars. Transaction costs may have been a little higher but trade continued.


Gold is here to stay and I'm sure for many more years to come. Perhaps for another few millenniums until man gets off this planet and finds another. (y)
Charlie Munger would not agree but im with you on this
 

Atilla

Legendary member
18,848 2,636
Charlie Munger would not agree but im with you on this

I don’t have the slightest interest in gold. I like working on understanding what works and what doesn’t in human systems. To me that is my…that’s not optional…that’s a moral obligation. If you’re capable of understanding the world, you have a moral obligation to become rational. I don’t see how you become rational hoarding gold. Even if it works you’re a jerk.



Straight talking guy. I like him. Each to their own. What ever floats his boat (y)


ADYOR!