While there are many precious metals, gold is the one that attracts the most attention from consumers, businesses, governments, and investors. Gold is a metal that has held its value very well over the years, while paper currencies and other assets have often been volatile. So, is it still worth investing in gold?
History of the price of gold
As you can see from the graph below, the price of gold has been relatively volatile over the years, but there is a distinctive uptrend. Historically, governments worldwide have maintained their gold reserves as a hedge against hyperinflation and other severe economic events. On 29th December 2020, the price of gold stood at $1882.30 per ounce.
Infamously, the then Chancellor of the Exchequer, Gordon Brown, sold more than half of the UK's gold reserves between 1999 and 2002. He sold at an average price of $275 and generated $3.5 billion for the Bank of England. In hindsight, the timing was disastrous, but the UK government was not alone in reducing its gold reserves. An uncoordinated bout of gold-selling by various central banks worldwide had a severe impact on the price.
This prompted, subsequently unfounded, long-term concerns that the safe-haven status of gold was under threat. While hindsight tells us Gordon Brown's timing could not have been worse, in reality, he was not the only Chancellor who called time on the "long-term benefits" of gold.
Hedge against inflation
Gold is viewed by many as a countercyclical investment, meaning it moves in the opposite direction to the worldwide economy and stock markets. This precious metal tends to mirror the increasing cost of living, a useful characteristic if there is high or hyperinflation. Consequently, it has proven to be a very useful hedge, maintaining relative value.
We know that gold is seen by many as a safe haven during difficult economic times. This is because of the relative scarcity of the metal and the ever-growing demand. You could argue that gold's historical safe-haven status can create a self-fulfilling prophecy of a rising price during challenging times.
Insurance policy against deflation
Due to central banks undertaking quantitative easing (printing money to support economies), very few investors have experienced deflation. We saw an element of deflation in the immediate aftermath of the 2008 financial crisis, brought on by the US mortgage market collapse. During deflation, prices fall, which places pressure on businesses' profit margins and leads to cost-cutting.
The most recent example of sustained deflation came during the Great Depression of the 1930s. The worldwide economy collapsed due to excessive debts, which had a severe knock-on effect on businesses and product/service prices. People began to hoard cash, frightened to invest, with many looking towards gold and gold coins as a safe haven for their wealth.
For the last few years, we have seen the US government, led by Donald Trump, playing hardball with their trading partners. This created substantial geopolitical uncertainty, prompting many investors to switch part of their portfolio into gold. As confidence in worldwide politics, and the worldwide economy, began to weaken, gold has been seen as a safe haven. The more concern on the international political front, the greater the demand for gold. On the flip side, when the US government began to rebuild bridges and rein in the often toxic rhetoric, many investors reduced their exposure to gold.
Interestingly, since Donald Trump emerged on the scene (and to a lesser extent, Brexit), there has been a greater degree of uncertainty in international investment markets. As a consequence, more investors are now maintaining a relatively high interest in gold. This provides a degree of backbone to their investment portfolios and protection against future geopolitical shocks.
Supply and demand
When you consider it can take between five and ten years to bring a new goldmine online, it is difficult to control supply and demand. At the turn-of-the-century, gold mining output was around 2,573 metric tons per annum. This has fluctuated somewhat over the years, although there was an increase to 3,300 metric tons in 2019.
Gold has always been in high demand across Asia. Now we have the growing Indian population showing a strong interest, too. Consequently, simple supply and demand factors will always have a bearing on the price of gold. However, on a long-term basis, demand for gold tends to outstrip supply.
The culture of gold
While investor appetite for gold is still relatively healthy, the culture surrounding gold is also worth considering. For example, gold bars have long been a traditional form of saving in China. Then we have the growing Indian market and the massive demand for gold, which often peaks in the wedding season around October. So, while many people use gold as a safe haven, offering a degree of protection to their portfolio, there is also physical demand for this mysterious precious metal.
It is worth noting that the first coins containing gold appeared back in 800 BC. Over the years, gold has played a prominent role with governments, central bank reserves, and investment markets.
Diversifying your investments
Those looking to use gold as a means of diversifying/protecting their investment portfolios tend to look towards direct exposure. Rather than investing in individual gold mining companies, many investors will use gold funds, which offer more direct exposure. This removes any of the specific risk associated with individual companies and places the focus wholly on the price of gold.
As you can see from the above graph, the price of gold has benefited from the economic and political challenges that began at the turn-of-the-century. In many ways, gold's recent performance reflects increased geopolitical concerns, predominantly revolving around the United States.
Gold can be a useful insurance policy
In common with many types of investment, supply and demand for gold can significantly fluctuate. As we touched on above, there are numerous issues to consider, but there is one obvious thing. Investors continue to perceive gold as a safe haven, and as a means of maintaining relative spending power during difficult times.
Therefore, gold should be considered as an option for your investment portfolio, a type of insurance policy, if you will. While nobody is suggesting switching your entire investments into gold, you should regularly discuss your exposure to this precious metal with your investment advisers.