Investing in Gold – How to and a History

Investing in gold is a tradition that goes back long before man created fiat currency. Gold is considered a precious metal and is the most liquid and widely traded of all the precious metals. Investing in gold normally occurs as a disaster hedge or inflation hedge (hedging against the loss of value of the home currency).

In 1946, at the Bretton Woods agreement, the price of gold was fixed at $35 per troy ounce. By fixing the price of gold and having the value of currencies attached to gold, the value of currencies remained fairly stable over time with very little inflation (or depreciation of the value of the currencies). In 1971 President Nixon authorized a change from the current system, which stopped the direct convertibility of the United States dollar to gold.

Therefore, today currencies are more volatile and are subject to depreciation (inflation of a country’s real goods and services). The benefit to a country’s government is its ability to issue debt and then inflate away their debt repayment obligations over time to a large degree. In other words, by issuing additional fiat currency, the government will depreciate the value of its home currency over time which will make the repayment of its debt easier over the years.

There is a large amount of stored gold in the world as gold is still viewed as a store of value. Forward looking views on the path of global economies, currencies and the likelihood of unforeseen disastrous events all affect the price of gold in the spot and futures markets.

The world’s central banks play an important role in the price of gold. The Washington Agreement on Gold (WAG), adopted in 1999 by Europe, the United States, Japan, Australia, the Bank for International Settlements and the IMF restrict total gold sales to less than 400 tons per year. The gold investment crowd has an element of conspiracy theorists that believes that the price of gold is actively manipulated by the world’s central banks in order to maintain confidence in the fiat currency. There may be some elements to this argument that makes sense; however, an all out manipulation in unlikely and the liquidity of the gold market would quickly dry up if all participants truly believed the game is fixed. Therefore, it is wise to understand the central bankEUR(TM)s role in gold, but their stance is not necessarily a driver of gold prices in the long run.

Gold as an investment does quite well when stocks, bonds and real estate do not adequately compensate investors for the risk they are undertaking. In periods of stagflation, gold is a logical investment to hedge against these risks. Also, gold does very well if there are crises or disaster scenarios in an economy such as expected war, disease or other pandemic situations. The flu scares that come about every few years seem to help support a higher gold price for example. Most readily observable behavior of gold however is its tendency to move in an inverse manner to the United States Dollar (USD). If the dollar is heading down, gold generally moves up. If the dollar is trending upwards, gold often stays flat and volatile or trends down.

Most investors invest in gold as a representation of its intrinsic value as opposed to stocks which are expected to grow overtime due to dividends and capital appreciation. In the long run and over the past 200 years, stocks have generally outperformed gold when there is a strong political system in place. However, there are cyclical troughs and peaks in the relationship between stocks and gold. This is often monitored through the Dow to Gold price ratio.

An investor may invest in gold through coin or bullion purchase (through a precious metals dealer which you can find in your local phone book), or you may pursue a more liquid form of ownership such as exchange-traded funds (ETFs), mutual funds , forwards , futures , and stock (shares) in gold mining companies. Be aware that when buying shares that you are often not getting a pure play exposure to gold. Companies often hedge their commodity exposure and may use various amounts of leverage. Both factors may significantly alter your performance when compared with the physical price of gold.  You can learn more about investing responsibly with us here.

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