Investing In Gold, Protection from Inflation
Why does the idea of investing in gold seem to be a good strategy for a growing number of people who may never have previously thought about exposure to commodities or real assets?
We know from ancient times that the yellow metal has had a special allure but what exactly are the reasons investing in gold is considered a good way to allocate some of your assets?
After all, you can’t carry a gold bullion bar around in your pocket and if you offered some gold coins when paying for a new car or buying some real estate, you would throw the sales assistant into confusion. Get your FREE INO Trading Alerts when you subscribe to our free Commodity Universe Newsletter here. Just complete the simple form below. It's as easy as 1-2-3!
So gold is not ideal as a currency for normal everyday transactions and given that it is stored as 400 Troy ounce bullion bars, it does not at first appear to be a practical investment.
But let’s look at why gold has advantages over other asset classes which traders look to for making profits and investors for growing capital and preserving their wealth.
Periods of Economic and Geopolitical Uncertainty
Throughout history people have turned to precious metals such as gold and silver because it is difficult to manipulate them in the same way that paper currencies can be manipulated.
When you think of investing in gold bullion, let’s say, you are doing it to preserve your wealth and maintain your purchasing power when we face exceptional and uncertain world events.
The price of gold rose strongly in January 1980 just after the Soviet Union invaded Afghanistan because of the uncertainty as to how it might affect assets and the global economy.
Gold is seen as an “insurance policy”, it is universally accepted and there is no counter party risk.
A Hedge Against Inflation
Look at how the US Federal Reserve has been forced to pump billions of more paper US dollars into the financial system as one bank after another was on the edge of collapse.
Indeed, on the day that Bear Stearns was allowed to go to the wall, the price of gold hit its all-time high of $1,011 a Troy ounce in March 2008.
Just think that every minute of every day the US Government is spending over $16,000 more than it gets back in tax revenues.
And this is before all the latest turmoil and the huge financial stimulus package proposed by President-elect Obama, along with the billions earmarked for the US car industry seeking approval in Congress.
Gold is viewed as a hedge against inflation over the longer term as its supply is relatively restricted and finite because it has to be mined, which is the main source of the metal. Contrast this with the money supply of paper money like the US dollar which central banks can easily expand. Studies which go back as far as the 18th century show that purchasing power over the long term is best preserved by investing in gold. Consider that over this long period a 1 per cent increase in US prices led to a 1 per cent increase in the US dollar price of gold. Hedging Against The US Dollar Many traders and investors see how gold along with other commodities can be used as a hedge against weakness in the US dollar. And of all the different commodity classes, gold is the best given that it has a correlation coefficient of between -0.4 and -0.6. The closer to -1 the greater an asset moves in the opposite direction to its reference, while +1 means it moves very much in line with the reference asset. Gold, A Low Volatility Commodity A study to look at how volatile commodities can be, found that gold was the least volatile, with a value of 15 per cent from the mean, while the base metals zinc, nickel and lead and crude oil were shown to be very volatile at around 35 per cent. Over the long term it is less volatile than a broad portfolio of international equities. One reason for the relatively low volatility of gold is that there is a good geographical spread of mining production and reserves, compared to other commodities, such as petroleum which is concentrated in the Middle East. This way it is less vulnerable to occasional price spikes caused by geopolitical tension.
A Means To Diversify Portfolios In recent years more and more pension and investment funds have added commodities and particularly gold to their portfolios to enhance diversification. This strategic decision to invest in gold is taken because the metal price does not materially move either positively or negatively compared to the main asset classes.
Portfolio managers are able to enhance the rate of return to a diversified portfolio by including even a small percentage of gold, say between 2 to 4 per cent of total assets.
Other related articles: Gold exchange traded fund, Liquid gold exposure Supply of gold, Mining as primary source
There are many ways for commodity traders and investors to consider gaining exposure to gold. They could use the paper route which includes gold futures or certificates or perhaps using an exchange traded fund (or ETF), which are owned by someone else. Alternatively, they could choose investing in gold mining shares, physical gold (including coins and bars), commercial bullion banks or the services of a private bullion custodian.
If you are thinking of looking closer at the merits of gold and whichever route you choose, you are advised to seek professional financial advice and to check the personal tax implications of your decision. One thing is certain, however, given the profound changes to the global economy, more people are now looking at the merits of investing in gold to preserve their capital.
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