8 Reasons for Owning Gold
8 Reasons for Owning GoldGold is respected throughout the world for its value and rich history, which has been interwoven into cultures for thousands of years.
Human fascination with gold is as old as recorded history. We don’t know for sure when the first human picked up a gold nugget and thought, “Hey, this is pretty cool.” However, flakes of gold have been found in Paleolithic caves dating back as far as 40,000 B.C.
Most archaeological evidence shows that humans who came into contact with gold were impressed by the metal. Since gold is found all over the world, it has been mentioned numerous times throughout ancient historical texts.
Throughout the centuries people have continued to hold gold for various reasons.
Below are eight reasons to own gold today.
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.
Gold has been a poor investment for many years. This is a statement which is almost universally accepted in today's world, but one which is only partially true. The truth is that gold has been a very poor investment when measured in US dollars.
Yet Gold has generally proven to be a sound investment when measured in terms of almost any other national currency.
The Indians and the Chinese, the world's largest buyers of gold, have seen the value of their gold investments increase by approximately 200% over the last decade. South East Asians and Koreans have also seen the value of owning gold due to collapses in their national currencies, particularly during Asian Financial Crisis and Global Financial Crisis.
Gold has historically been an excellent hedge against inflation. Hedging is strategically using financial instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another. Technically, to hedge you would invest in two securities with a negative correlation.
Gold’s 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.
As inflation is mainly caused by an increase in the money supply, deflation is primarily a result of a decrease in the money supply. However, a decline in the general price level may be also a result of genuine economic growth and higher productivity. This was precisely the price deflation which occurred when the gold standard was in place.
As rapid growth in the supply of goods outpaced the gradual growth in the money supply, there was a mild deflationary trend in the 19th century. Such deflation is obviously positive for the economy. However, prices may fall due to hoarding of cash or bank credit deflation, which occurred during the Great Depression when there was a significant contraction in credit and money supply. This kind of deflation is often a result of long periods of artificial expansion of fiat money and its impact on the economy is subject to debate.
The relative purchasing power of gold generally soars while other prices drop sharply.
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 major price movements in response to periodic crises (Asian Financial Crisis, Global Financial Crisis etc.). Its price often rises the most when confidence in governments is low.
Supply Constraints Much of the supply of gold in the market since the 1990s 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.
Gold is a proven store of value, especially for its role as a safe-haven investment in times of geopolitical crises, but according to new analysis from the World Gold Council (WGC), the yellow metal plays a critical role in portfolios with exposure to emerging markets (EM).
The WGC notes in its latest ‘Investment Update’ that economic growth is a key driver of gold demand, especially in EM countries where there is a high affinity for gold as jewelry and investment. At the same time, gold tends to perform well in periods of crisis.
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.
There are many reasons to allocate a portion of a portfolio in gold, including the constant fiat currency debasement by all governments around the world.
In August 2017, Ray Dalio, of Bridgewater Associates LP, the biggest hedge fund in the world, recommended investors hold 5 to 10% of their portfolios in gold to hedge against political risks. According to Dalio:
So it's a diversifying asset that is sensible, and that's the main reason to have gold in the portfolio, 5 to 10%.
“Gold serves a purpose. It is first of all, a diversifier against other assets. You know, we have this risk on, risk off thing. We also have a monetary system. The Bretton Woods monetary system began after World War II, and it had the dollar as the world's reserve currency. There's a risk there. There's a lot of dollar denominated debt and so on. If somebody felt they didn't want to hold that, and so you could have exposures to that.”
Properly diversified investors combine gold with stocks and bonds in a portfolio to reduce the overall volatility and risk.
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.
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