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INVESTING IN GOLD
For thousands of years, gold has been valued as a global currency, a commodity, aninvestment and simply an object of beauty. As financial markets developed rapidly duringthe 1980s and 1990s, gold receded into the background and many investors lost touch withthis asset of last resort. Recent years have seen a striking increase in investor interest ingold. While a sustained price rally, underpinned by the fact that demand consistentlyoutstrips supply, is clearly a positive factor in this resurgence, there are many reasons whypeople and institutions around the world are once again investing in gold. This websiteprovides you with the background to these reasons and describes the definingcharacteristics of the gold market from an investor's point of view.
Why gold?
Gold has attracted investors throughout the centuries, protecting their wealth and providing a 'safe haven' in troubled or uncertain times. This appeal remainscompelling for modern investors, although there are also a number of other reasons that underpinthe widespread renewal of investor interest in gold.
Safe haven
In volatile and uncertain times, there is typically a 'flight to quality' as investors seek to protecttheir capital by moving it into assets considered to be safer stores of value. Gold is among ahandful of financial assets that do not rely on an issuer's promise to pay, offering refuge fromdefault risk. It provides insurance against extreme movements that often occur in the value of traditional asset classes in unsettled times.
Most investment portfolios are invested primarily in traditional financial assets such as stocksand bonds. The reason for holding diverse investments is to protect the portfolio againstfluctuations in the value of any single asset or group of assets that react in a common fashion.Portfolios containing gold are generally more robust and less volatile than those that do not.
Market cycles may come and go, but - over the long term - gold keeps its purchasing power. Itsvalue, in terms of the real goods and services that it can buy, has remained remarkably stable. Incontrast, the purchasing power of many currencies has generally declined due to the impact of rising prices for goods and services. As a result, gold is often bought to counter the effects of inflation and currency fluctuations.
Gold is often used as an effective hedge against fluctuations in the US dollar, the world's maintrading currency. If the dollar appreciates, the dollar gold price falls, while a fall in the dollar relative to the other main currencies produces a rise in the gold price. While this may also be trueof other assets, gold has consistently proved among the most effective in protecting againstdollar weakness.
On the whole, gold is significantly less volatile than most commodities and many equity indices.In this respect it tends to behave more like a currency. Including assets with low volatility in a portfolio will help to reduce overall risk, with a beneficial effect on expected returns. Risk factors that may affect the gold price are quite different in nature from those that affect other assets.
As is true of all asset prices, gold's price moves in response to the changing balance betweensupply and demand. Mine production is relatively inelastic due to the long lead times that exist ingold mining, which explains why the rally in the gold price since 2001 has still not engenderedan increase in production levels. Meanwhile, demand has shown sustained growth, due at least in part to rising income levels in gold's key markets. This has created the foundation for the most positive outlook the precious metal has known for a quarter of a century.
Gold and inflation
The value of gold, in terms of the real goods and services that it can buy, has remained largelystable for many years. In 1900, the gold price was $20.67/oz, which equates to about $503/oz intoday's prices. In the five years to end-December 2008, the price of gold averaged around $606.So the real price of gold has endured a century characterised by sweeping change and repeatedgeopolitical shocks and more than retained its purchasing power. In contrast, the real value of most currencies has generally declined.
Investors in gold can point to a growing body of research supporting gold's reputation as a protector of wealth against the ravages of inflation. Market cycles come and go, but extensiveresearch from a range of economists has demonstrated that, over the long term, through bothinflationary and deflationary periods, gold has consistently maintained its purchasing power.In the short run, experience has shown that gold can deviate from its long-run inflation-hedge price, and, when enjoying a sustained buoyant period, as is currently the case, can offer opportunities for impressive returns.
Gold and risk
Financial instruments usually carry three main types of risk.
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Credit risk:
the risk that a debtor will not pay
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Liquidity risk:
the risk that the asset cannot be sold as a buyer cannot be found.
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Market risk:
the risk that the price will fall due to a change in market conditions.Gold is unique in that it does not carry a credit risk. Gold is no one's liability. There is no risk that a coupon or a redemption payment will not be made, as for a bond, or that a company willgo out of business, as for an equity. And unlike a currency, the value of gold cannot be affected by the economic policies of the issuing country or undermined by inflation in that country. At thesame time, 24-hour trading, a wide range of buyers - from the jewellery sector to financialinstitutions to manufacturers of industrial products - and the wide range of investment channelsavailable, including coins and bars, jewellery, futures and options, exchange-traded funds,certificates and structured products, make liquidity risk very low. The gold market is deep andliquid, as demonstrated by the fact that gold can be traded at narrower spreads and more rapidlythan many competing diversifiers or even mainstream investments.Gold is of course subject to market risk, as is clear from the experience of the 1980s when thegold price declined sharply. But many of the downside risks associated with the gold price arevery different to the risks associated with other assets, a factor which enhances gold's
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