Tue. Oct 20th, 2020

Why Should You Invest in Gold?

For some investors, tracking stock prices of the companies in their portfolio is a morning routine; for others, who are well invested in currency trading, checking their currency pair positions on MetaTrader apps is an everyday habit. But, for the folks solely interested in the associated value of gold, the daily price per gram or ounce of gold is as important as breakfast itself. When the value of gold drops considerably, these avid gold buyers swarm the local shops for a little bling-bling shopping.

But what makes people buy gold? It doesn’t produce income, and you can only profit from it if it’s sold for a higher price which is, of course, dependent on the next buyer (something you can’t purely rely on), and yet people are still hooked into the buying and selling of this commodity — even more so, buying for the long haul. The question we would like to answer in this article is why should you invest in gold and if it is really worth the time and money.

 

As a Safe Haven?

Gold is often associated with a sense of security, a haven in times of uncertainty. In fact, some investors would bank on gold prices rallying when the stock market plunges. Moreover, gold, to some cultures, is also attributed to safety and stability and is highly regarded as the only asset that can be easily passed on to the next generation without being too concerned about the common bugbears of other assets.

The stock market, for example, has its fair share of steep declines, the risk of default always comes along with debt-based assets, and farmland is subject to its numerous hassles (seasons, calamities). But, how sure are we that gold will hold up its end and deliver us from financial catastrophes?

Correlation with Interest Rates

One misconception about gold is an increase in U.S. interest rates negatively affects its price; this opinion presumably found its roots in the 2008 financial crisis when a period of low-interest rates catapulted gold prices up to its highest at $1896.50 on August 22, 2011. However, we can see that gold started dipping after hitting its peak and that is during a time when federal funds rate were below 0.20%.

Essentially, the gold standard was an original solution to the excessive printing of money which leads to inflation and if we cite the reason why interest rates are increased in the first place (to fight inflation), it makes more sense to assume that gold may have a tendency to move along with interest rates.

Gold and the US Dollar

Now, ceteris paribus, a higher interest rate would naturally bolster the attractiveness of a currency, but despite this, gold and the greenback seem to exhibit a negative relationship meaning that they move in opposite ways. The chart below shows how the strength of the US dollar presses the value of gold downwards and vice versa. It would appear as though the waning faith on the US dollar translates to the psychological allure of gold.

Macrotrends

The movement of gold

Macrotrends

In ’73, when Nixon scrapped the US from the Gold Standard in a move to prevent further depletion of U.S. gold reserves, the price of gold spiked to a high of $127, and when Americans were given the green light to be able to own gold once again, gold’s price reached $197.50 in 1974. And, by 1980, gold touched $843 an ounce.

The subsequent rise of gold was stoked by fears of war, turmoil, and instability, but as soon as those fears relax, gold’s price cools down. For an asset adored for its stability, it sure is volatile.

Supply and demand

Most experts would agree that supply and demand are still the two main factors pulling the strings of gold prices. After all, gold is still a commodity with limited supply and people who trade the precious metal are the ones haggling over the prices.

The approximate quantity of unmined gold is around 54,000 tonnes (about 22% of all available gold including the above-ground stocks) according to the World Gold Council, and yet the demand surged in the third quarter of 2018 by 28%, owing to investors capitalizing on the lower prices.

Gold as an investment

Because gold behaves more like a currency, amassing a large quantity of it would be similar to stashing cash under the bed but with the exception of getting immunized from inflation. Unless the whole world dumps the fiat money and reverts to the gold standard system, owning gold doesn’t appear to be a practical investment choice.

Also, the argument that gold appreciates during difficult times, as people pour more money into the metal, is tenuous to the point where it’s unreliable to believe so. A time machine back to the 1934 Gold Reserve Act might make you think otherwise about investing in gold.

The special value of gold

Still, there is a sort of sentimental attachment investors have with gold, and this is probably ingrained in our DNA because of how our ancestors conducted trade then. In fact, money managers and some savvy investors even allocate a small portion of their assets to gold — it’s their insurance or their backup plan in case things get awry. But, I have to agree with the great Warren Buffett on his opinion about gold:

“If you buy an ounce of gold today and you hold it a hundred years, you can go to it every day, you could coo to it, and you can caress it, and you can fondle it, and a hundred years from now, you have an ounce of gold, and it won’t have done anything for you in between.”

To Warren, it would be better to own a hundred acres of farmland as it produces income for you every year.

Trading gold

Given that gold behaves like a currency, trading it is a better alternative than storing it away for eternity because an investor can leverage the psychological tendencies of gold buyers to their advantage. It is certainly worth the time to profit from its price fluctuations, but not if you wait a hundred years to see the same ounce of gold just shinning back at you.

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