Investors can invest in gold through an exchange-traded fund (ETF), buy stocks of gold miners and affiliated companies, and purchase physical products. There are as many reasons for these investors to invest in metals as they do for these investments.
Some people believe that gold is a barbaric relic and no longer possesses the monetary qualities of the past. In the modern economic environment, paper money is the currency of choice. They argued that the only advantage of gold is that it is a material used in jewelry. On the other hand, some people assert that gold is an asset with various inherent qualities, which makes it unique and necessary for investors to hold their investment portfolios.
- Goldbugs often encourages investors to hold precious metals as part of a diversified long-term investment portfolio.
- Gold is regarded as a hedging tool for hedging inflation, as well as a hedging tool from thick to thin.
- However, holding gold comes with unique costs and risks. Data shows that historically, several claimed advantages of gold are disappointing.
A brief history of gold
In order to fully understand the purpose of gold, it is necessary to review the beginning of the gold market. The history of gold in society even began as early as the ancient Egyptians, who began to make jewelry and religious artifacts. However, it was not until around 560 BC that gold began to act as currency. At that time, merchants wanted to create a standardized and easily transferable form of currency to simplify trade. Creating a gold coin with a seal seems to be the answer, because gold jewelry has been widely accepted and recognized in every corner of the earth.
With the emergence of gold as a currency, its importance continued to grow throughout Europe and the United Kingdom. Relics from the Greek and Roman Empires were prominently displayed in museums around the world. The United Kingdom developed its own metal currency in 775. The pound (symbolizing a pound of pure silver), shillings and pennies are based on the amount of gold (or silver) it represents. Ultimately, gold symbolizes the wealth of Europe, Asia, Africa and the Americas.
American Bimetal Standard
The U.S. government continued this golden tradition by establishing a bimetallic standard in 1792. To put it simply, every unit of currency in the United States must be backed by gold or silver. For example, 1 US dollar is equivalent to 24.75 grams of gold. In other words, the coins used as currency simply represent the gold (or silver) currently deposited in the bank.
But this gold standard did not last forever. In the 1900s, several key events eventually led to gold’s departure from the monetary system. In 1913, the Federal Reserve was established and began issuing promissory notes (the current version of our banknotes) that can be converted into gold on demand. The Gold Reserve Act of 1934 gave the US government ownership of all circulating gold coins and stopped minting any new gold coins. In short, the bill began to establish the idea that gold or gold coins were no longer needed as currency. The United States abandoned the gold standard in 1971, when its currency was no longer backed by gold.
Gold in the modern economy
Although gold no longer supports the U.S. dollar (or other global currencies), it still has important significance in today’s society. It is still important to the global economy. To verify this, there is no need to further look at the balance sheets of central banks and other financial organizations (such as the International Monetary Fund). At present, these organizations are responsible for holding nearly one-fifth of the world’s ground supply of gold. In addition, several central banks have increased their current gold reserves, reflecting long-term concerns about the global economy.
The reason gold is so important in the modern economy is that it has successfully preserved the wealth of thousands of generations. However, this is not the case for paper-denominated currencies. To put things in perspective, consider the following example:
In the early 1970s, one ounce of gold was equal to 35 U.S. dollars. Assuming that at that time, you can choose to hold 1 ounce of gold or just hold 35 dollars. They will all buy you the same things, such as a brand new suit or a beautiful bicycle. However, if you own an ounce of gold today and convert it to today’s price, it’s still enough to buy a brand new suit, but that can’t be said for $35. In short, if you decide to hold $35 instead of 1 ounce of gold, you will lose a lot of wealth because the value of gold has increased, and the value of $1 has been eroded by inflation.
Gold hedges the dollar
In an economic environment where investors face a depreciation of the U.S. dollar and rising inflation, the idea of gold preservation is even more important. Historically, gold has always been a hedge against these two situations. As inflation rises, gold usually appreciates. When investors realize that their funds are depreciating, they will begin to invest in hard assets that have traditionally maintained their value. The 1970s was a typical example of rising gold prices amid increasing inflation.
The reason why gold has benefited from the depreciation of the U.S. dollar is that gold is priced in U.S. dollars around the world. There are two reasons for this relationship. First, investors who are considering buying gold (that is, the central bank) must sell U.S. dollars to make this transaction. As global investors seek to diversify the U.S. dollar, this will eventually push the U.S. dollar lower. The second reason has to do with the fact that the weakness of the U.S. dollar makes gold cheaper for investors holding other currencies. This has led to an increase in demand from investors holding currencies that have appreciated against the U.S. dollar.
Gold as a safe haven
Whether it is tensions in the Middle East, Africa or elsewhere, it is becoming increasingly obvious that political and economic uncertainty is another reality of our modern economic environment. Therefore, in times of political and economic uncertainty, investors usually view gold as a safe haven. why is it like this? Well, history is full of the collapse of empires, political coups, and the collapse of currencies. In such a period, investors who hold gold can successfully protect their wealth, and in some cases, they can even use gold to get rid of all turbulence. Therefore, whenever news events suggest some type of global economic uncertainty, investors usually buy gold as a safe haven.
Gold as a diversified investment
Generally speaking, gold is regarded as a diversified investment. Obviously, gold has always been an investment that can add diversification to your investment portfolio, regardless of whether you are worried about inflation, the depreciation of the U.S. dollar, or even protect your wealth. If your focus is only on diversification, then gold has nothing to do with stocks, bonds, and real estate.
Gold as a dividend asset
Compared with income investors, gold stocks are generally more attractive to growth investors. Gold stocks generally rise and fall with the price of gold, but there are also well-managed mining companies that can make a profit even if the price of gold falls. The rise in the price of gold is usually amplified in the price of gold stocks. A relatively small increase in the price of gold can result in significant gains in the best gold stocks, and owners of gold stocks generally receive a higher return on investment (ROI) than owners of physical gold.
Even investors who focus primarily on growth rather than stable income can benefit from choosing gold stocks that have shown historically strong dividend performance. When the industry rises, dividend-paying stocks tend to show higher returns, and when the entire industry is in a downturn, their performance is better than non-dividend-paying stocks—on average almost twice the latter.
Gold mining industry
The mining industry, including companies that mine gold, may experience high volatility. When evaluating the dividend performance of gold stocks, please consider the company’s dividend performance. Factors such as the history of the company’s dividend payment and the sustainability of the dividend payment rate are two key elements that need to be checked in the company’s balance sheet and other financial statements.
If a company continues to maintain low debt levels and strong cash flow, and the historical trend of company performance shows that debt and cash flow figures are steadily improving, then its ability to maintain healthy dividends will be greatly enhanced. Since any company will experience growth and expansion cycles when it takes on more debt and has a low cash balance on hand, it must analyze its long-term data rather than a shorter financial time frame.
Different ways to own gold
One of the main differences between investing in gold hundreds of years ago and today is that there are more investment options, such as:
- Gold futures
- Gold company
- Gold ETF
- Gold Mutual Fund
- Gold jewelry
Wrong time to invest in gold?
To determine the investment value of gold, let’s compare it with the performance of the S&P 500 index over the past 5 years (as of April 2021). During this period, compared with the Standard & Poor’s 500 Index, gold’s performance was slightly inferior. The S&P index’s total return rate was close to 100%, while the gold return rate during the same period was only 42.5%.
In other words, the time period we observe is very important. For example, gold outperformed the Standard & Poor’s 500 Index during the 10 years from November 2002 to October 2012, and the total price appreciated 441.5%. On the other hand, the S&P 500 Index rose 58% over the same period.
The point here is that gold is not always a good investment. The best time to invest in almost all assets is when market sentiment is negative and asset prices are low, as mentioned above, when it regains its favor and offers huge upside potential.
Every investment has pros and cons. If you are opposed to holding physical gold, buying shares of gold mining companies may be a safer choice. If you think gold can be a safe bet against inflation, investing in coins, gold and silver or jewelry is your path to gold-based prosperity. Finally, if your main interest is to use leverage to profit from rising gold prices, the futures market may be your answer, but please note that any leverage-based holding involves considerable risks.