Gold as an investment

Why Gold is a Popular Investment

Of all the precious metals, why does gold reign supreme as an investment? Is it because of its historical significance or its ability to diversify portfolios?

The Historical Significance and Modern Relevance of Gold

Gold has been used throughout history as money and was even pegged to the US dollar at a rate of $35 per troy ounce until 1971. This historical significance makes it a symbol of wealth and stability, but what drives its value today? The London gold fixing, established in 1919, remains the most common benchmark for the price of gold.

Supply and Demand: The Driving Forces Behind Gold Prices

The price of gold is driven by supply and demand, including speculative demand. Central banks hold a significant portion of all above-ground gold as official reserves, with limits on sales set by agreements like the Washington Agreement on Gold. Some countries, such as Russia and China, are increasing their gold reserves to diversify their portfolios.

The Role of Sentiment in Gold Prices

While annual mine production is close to 2,500 tonnes, most of the gold ever mined still exists in accessible form. The price is mainly affected by changes in sentiment rather than annual production. Annual mine production goes into jewelry, industrial and dental uses, while retail investors and exchange-traded funds account for around 500 tonnes.

Gold as a Hedge Against Economic Uncertainty

The price of gold can be influenced by various macroeconomic variables such as oil prices, quantitative easing, currency exchange rates, and equity market returns. Gold may be used as a hedge against inflation, deflation, or currency devaluation, but its efficacy has been questioned.

Gold in Jewelry and Industry

Jewelry accounts for over two-thirds of annual gold demand, with India being the largest consumer in 2009. Industrial, dental, and medical uses account for around 12% of demand. The recycling of second-hand jewelry has become a multibillion-dollar industry, making it an essential part of the gold market.

Investing in Gold: Bars, Coins, and ETFs

Bars are the most traditional way to invest in gold, available in various sizes with lower price premiums than coins. Tungsten is ideal for certain purposes due to its density matching that of gold, making it less expensive than gold.

The London Bullion Market (LBMA) System

Good delivery bars in the LBMA system have a verifiable chain of custody and can be easily bought and sold within the system. However, if removed from vaults, they must be re-assayed before being returned to the LBMA chain according to ‘Good Delivery Rules.’

Gold Coins: A Common Way to Own Gold

Gold coins are a common way of owning gold, priced according to their fine weight plus a premium based on supply and demand. The Krugerrand is the most widely held gold bullion coin.

Gold Rounds: Not as Collectible as Coins

Gold rounds are similar in size to gold coins but have no currency value, with some having no additional metals for durability purposes. They are not as collectible as gold coins.

Exchange-Traded Products (ETPs)

Gold exchange-traded products include ETFs, ETNs, and CEFs, which can be traded like shares on the major stock exchanges. The first gold ETF was launched in March 2003. ETPs represent a way to gain exposure to gold without physical bars but carry risks beyond those inherent in the metal itself.

Gold Certificates: A New Risk

Gold certificates allow investors to avoid physical bullion risks by taking on new risks associated with the certificate itself. Allocated certificates are correlated with specific numbered bars, while unallocated certificates are fractional reserve banking and do not guarantee an equal exchange for metal.

Different Types of Gold Accounts

There are various types of gold accounts available, including allocated and unallocated accounts. Unallocated accounts impose varying levels of intermediation between clients and their gold but do not guarantee an equal exchange for metal in the event of a run on the issuer’s gold on deposit.

Bullion Banks and Vaulted Gold

Bullion banks typically deal in large quantities, while vaulted gold offers private investors ownership in professionally vaulted gold starting from minimum investment requirements. Derivatives such as gold forwards, futures, and options trade on exchanges and OTC directly.

Investing in Gold Mining Companies

Investors can also buy shares in gold mining companies instead of buying gold itself. This option is subject to various risks, including flooding, subsidence, mismanagement, and nationalization, which can affect share prices even when the gold price increases.

Fundamental Analysis: Analyzing the Macroeconomic Situation

Investors using fundamental analysis analyze the macroeconomic situation, including international economic indicators such as GDP growth rates, inflation, interest rates, productivity, and energy prices. They also analyze the yearly global gold supply versus demand.

The Performance of Gold Bullion vs Stocks

The performance of gold bullion is often compared to stocks as different investment vehicles. Gold is regarded by some as a store of value without growth, while stocks are regarded as a return on value with growth from anticipated real price increase plus dividends.

Gold’s Volatility and Long-Term Performance

One argument follows that in the long-term, gold’s high volatility when compared to stocks and bonds means that gold does not hold its value compared to stocks and bonds. However, investors may choose to leverage their position by borrowing money against their existing assets and then purchasing or selling gold on account with the loaned funds.

Tax Considerations for Gold Investments

Gold maintains a special position in the market with many tax regimes, regulated very differently around the world and depending on respective national laws. Sales tax on investment gold varies by country, with some countries exempting high-purity bars and coins from VAT while others tax jewelry as a consumer good.

Fraudulent Activities Involving Gold

Gold attracts various forms of fraudulent activity, including cash-for-gold scams, high-yield investment programs masquerading as legitimate gold investments, advance fee fraud schemes, gold dust sellers, counterfeit gold coins, shares in fraudulent mining companies, and instances where sellers keep possession of the gold.

Investing in gold is a complex journey, filled with opportunities and challenges. Whether you’re looking for diversification or a hedge against economic uncertainty, understanding the various forms of gold investments can help you make informed decisions. Remember, every investment comes with its own set of risks, so always do your due diligence before diving into the market.