Gold, what is it good for?

Gold, what is it good for?

Well, that would depend who you ask. Some people will tell you that gold was, is and always will be the greatest investment of all time. It generally holds its value, has been around for millennia and is scarce. However, the companies selling gold will gladly take your cash in exchange for it, which should tell you something about gold’s short-term prognosis.

By simply looking at the numbers, it is obvious that a continuous and consistent rise in the price of gold is impossible. If it had risen in value since it first became considered valuable thousands of years ago, its current price would be unfathomable. The price of the metal clearly rises and falls daily just like any other commodity.   

So, what causes the price to move?

The supply of gold is almost static. Barely any is produced annually, and this amount tends not to fluctuate significantly. Therefore, restricted supply is clearly not the main driving force of price movements given that it decreases as well as increases.

Gold is not a commodity for speculators. No one, or at least no one sane, buys physical gold in the hope that it will quadruple in value over the next year. Buying gold is typically a defensive measure. People buy gold to protect against risks such as currency devaluation, inflation and the failure of other less tangible assets. As such, the demand for gold rises as people lose confidence in other assets. Emotional demand is by far the biggest factor in gold price movements. For those who already have gold, this is a positive, but it is also where those who panic tend to lose out.

As the markets tumble and people panic, the demand and therefore price of gold, shoots up. Savvy investors who bought gold when the price was low, can sell their gold to prop-up their portfolios performance, whilst the panicking masses start to buy gold, now at a high price.

As the price rises you have to ask yourself if buying now is a good idea or if you missed that boat already.

The problem with gold is that it doesn’t pay a dividend, it is a dead asset and in no way an income producing asset. Gold is only worth its market price, so sitting on gold for the short to medium term means your money is out of the markets and not generating any wealth.

The graph above shows that if you bought gold anytime from the middle of 2011 to the end of the first quarter of 2013, unless you were happy to sell at a lower price than you bought, you will have had to wait until at least the middle of 2019 to get your money back, and there is a strong chance for many people who bought in that time period, that selling now would still be a loss.

At the very least they will have lost to inflation, let alone the gains they would have made from that money being in the markets, which have shot up.

To put it further in perspective, someone investing $10,000 into the S&P 500 in August 2011 would now have $31,477. $10,000 of gold bought at that same time when the price hit $1900 an ounce, would now be worth $8,684.

Almost 10 years of tied up wealth with no returns, missed growth opportunity and inflation erosion, unless they took the loss and sold at a lower price.

If you are a supremely wealthy individual or a bank looking to park vast sums of wealth for a very long time, gold could be an attractive option. Alternatively, with that same money you could buy up huge swathes of land and real estate, assets that produce an income, however, you may have done that already and want to diversify.

For the rest of us, whilst it is a desirable thing, it may not be a rational thing to buy. It is easy to attach a lot of prestige to gold and to believe that it represents an objective, unswayable measure of wealth, but it doesn’t. The price rises and falls just as it does for anything else. These movements can indeed convey information about consumer confidence, the probability of stock price increases and much else. Recognising gold’s place in the market is important, but it’s better not to attach too much or too little significance to it.

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Andrew Hipshon

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