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Throughout history, there’s never been any possession more sought after than gold. Because of its universal appeal and salability, it provided the trust and backing needed for the rise of many fiat (government) currencies around the world. Today, gold is still recognized as being valuable and ranks as one of the oldest forms of “money” that continues to be accepted in modern civilization.
Despite its long, validated history of use, many modern-day investors often neglect the inclusion of gold in their portfolios. Some may see the upward trending stock market over the past few decades or surge in cryptocurrency prices as more lucrative and exciting. This leaves many to question: Does gold still matter in 2022?
In general, there are a lot of reasons why people should still invest in gold. Gold has been proven to serve not only as an excellent store of wealth but also as a hedge against inflation, which is definitely something to consider when prices begin to climb. Additionally, it can also help to round out an investor’s portfolio providing them with better asset allocation than someone who may hold 100 percent equities.
In this post, we’ll explore what makes gold so valuable and how investors can use this information to their benefit. We’ll talk about a few ways to actually invest gold and determine if it's right for you.
Should You Invest In Gold?
Before an investor can know if gold holds a place in their portfolio, they need to first understand why people typically would want to buy it in the first place. Here are a few of the main reasons investors should consider.
Investing In Gold To Preserve Wealth
For centuries, gold has served as a dependable way to store and pass on wealth. Whereas other forms of money like cattle, Cowrie Shells, and even silver have come and gone throughout history, gold has retained a special ability to be perceived as “desirable”; especially among those who set monetary policy such as kings, rulers, and other nobility.
Perhaps this is due in part to the nature of the precious metal itself. Unlike other contenders such as silver and copper, gold doesn’t corrode and maintains its uniquely beautiful appearance. Gold is also easy to manipulate into other shapes making it ideal for applications like coins or jewelry.
This fact became so well recognized that when governments started introducing their fiat paper currency, gold was the means used to back it up and build trust among their people. The official start of the Gold Standard began with the Coinage Act of 1816 when England tied the value of pound sterling to the price of gold. Not long after, other countries, including the United States, followed suit.
Even though the Gold Standard eventually ended and most of the economy is now tied to the value of the U.S. dollar, the precious metal is still hoarded by nations around the world. The United States has the largest reserve with a reported 8,133 metric tons of gold, half of which is kept at the U.S. Bullion Depository in Kentucky (also known as Fort Knox). Other countries, particularly those in Europe, also report holding thousands of tons of gold in their respective treasuries.
While these governments may no longer tie their currencies to the Gold Standard, it should be clear from the size of these reserves that the metal still maintains its time-tested significance.
Investing In Gold As An Inflation Hedge
Another reason investors will flock to gold is that its value tends to rise as the cost of living also naturally increases. This makes it particularly useful as a hedge against inflation.
To see this in action, take a look at the chart below showing the value of gold (orange) against the U.S. dollar (blue) over the last 15 years. As we move from left to right, you can see that every time the value of the dollar was in a decline, gold was trending upward, and vice versa. This suggests the two have a natural inverse relationship.
This situation becomes further amplified during periods of relatively high inflation. During the 1970s when the U.S. was experiencing double-digit increases, fear and uncertainty motivated many investors to turn to gold. This caused its value to change from $35 per ounce in 1971 to $850 per ounce by 1979 – a 2,300 percent gain!
Bitcoin enthusiasts like to argue that the cryptocurrency will replace gold as the primary way to hedge against inflation. However, that theory still has yet to come to fruition.
Over the past decade, Bitcoin has crashed at least three times losing as much as 80 percent of its value in the decline. This trend combined with a history of volatility makes it more of a speculative alternative investment than one that could serve a role of safety and security.
Investing In Gold For Diversification
Because of its power to preserve wealth, hedge against inflation, and other unique characteristics, gold is often seen as a smart way to round out a well-balanced investment portfolio.
Recall that to manage an investor’s downside, diversification is needed within their portfolio. This is typically done by holding investments that are not closely correlated to one another.
Whereas most novice investors might build their nest eggs using a handful of stock and bond-based funds, experienced wealth management professionals will take a more comprehensive approach to protect against the downside. To accomplish this, they’ll usually look to include:
- Commodities such as precious metals (gold and silver), energy resources (oil and natural gas), and agricultural goods (wheat)
- Real estate
- Alternatives such as futures, options, and other financial derivatives
For gold specifically, the classic rule of thumb is that it should be limited to no more than 5 to 10 percent of the overall portfolio.
What Affects The Investment Price Of Gold?
Gold is a different type of asset than what someone would typically think of as an investment. Unlike stocks and bonds, it does not produce anything, pay dividends, or entitle the owner to collect interest.
To put it bluntly, the price of gold is speculative. Its value will always be relative to what someone in the open market is willing to pay; hopefully more than what you paid for it.
However, with such a long history of price movements and trends, investors can take notice of what’s happening in the world around them and use that information to benefit their portfolios. Here are some of the most widely recognized influences and how they affect the price of gold.
Stock Market Activity
The first thing to know about the price of gold is that it typically moves in an inverse direction of the stock market. When stocks are doing good, investors will become greedy and flock to the market hoping to find an opportunity to capitalize on the rising trend. This means they may sell off their gold holdings which then causes the price to drop.
The reverse is also true during stock market declines. When the economy enters into a recession, investors will sell off their stocks and instead pour the money into gold. As a result, the price of gold will soar for as long as the recession persists.
This relationship can be observed during the last major U.S. recession back in 2008 (i.e., the Great Recession). As stocks started to cool off from 2007 to 2008, the price of gold began to climb. This trend continued well into the depths of the recession until stocks finally started to pick back up again in late 2009.
Similar to the logic of using gold to hedge against inflation, this reaction makes sense. As investors see their life savings decline in value and literally evaporate in front of their eyes, they will turn to gold as a way to counterbalance the losses and preserve some portion of their wealth.
Gold Mining Rates
Part of what helps gold to maintain its relative value and price stability is the fact that it's not something that can be readily produced, even with additional resources.
As the price of gold increases, gold mining companies will naturally ramp up production to find more of it. But because gold is increasingly becoming harder to find, the extra effort does not always produce more results. Therefore, the incentive of selling their product at a higher price can be negated by the diminished returns of the mining expense.
This is different from other metals which can be easily unearthed or even fiat currency (which the government can always print more of). Gold has scarcity, and without more of it to readily introduce into the market, the price of all the existing gold will climb whenever there’s demand.
The Federal Reserve’s Impact On Gold Prices
Another major factor that will cause the price of gold to shift is the policies set in motion by the U.S. Federal Reserve. The purpose of the Federal Reserve is to ensure the stability of the economy, employment, and its institutions with respect to the financial system as a whole. Oftentimes, this is done through the manipulation of monetary policy by changes to the Federal Reserve interest rate.
For instance, when the stock market enters into a recession, the Fed may cut rates in an effort to bolster the economy. Companies can borrow money more cheaply, produce enough goods to meet market demand, and employ more people. As the economy then begins to stabilize, the Fed is then supposed to return the interest rates to their previous levels so that they can repeat this cycle again someday.
Another time this strategy of changing interest rates is used is during periods of high inflation. When prices are too high, increasing interest rates will help reduce demand placing downward pressure on the price of most goods. Usually, this causes the stock market to pull back, but it's generally a temporary reaction as the economy adjusts to a level of normalcy.
As investors, it's important to pay attention to the meetings of the Federal Reserve and their announcements. If the markets dip and it's suspected that the Fed will lower interest rates, this could be an opportunity for gold investors to capitalize.
Interest In Competing Assets
While many of the trends we’ve demonstrated so far can be found clearly throughout the past century, the past decade has experienced a unique disruption with the introduction of a relatively new asset: Bitcoin.
Despite its volatility, investors continue to pour money into Bitcoin as a new perceived way to hedge against inflation. Enthusiasts of the crypto argue that, like gold, this is because Bitcoin has scarcity. It’s written in the code that only about 21 million Bitcoin can ever be created.
This could explain why Bitcoin has had such an incredible run-up over the past decade. And investors seem to be bullish on the idea. If you compare Bitcoin's $700 billion market capitalization against the $2.6 trillion worth of gold, then it could be interpreted that the cryptocurrency has effectively stolen a 20 percent share of the market from gold.
However, it's far too early to tell if Bitcoin’s ability to serve as a hedge will hold true. This theory assumes that Bitcoin will continue to stay in demand by investors. It would also mean that Bitcoin would have to do a much better job of demonstrating price stability.
How Do You Invest In Gold?
Investing in gold is something that anyone can do. There are actually several ways investors can add the precious metal to their portfolios.
Buy Gold Bullion And Coins
One of the unique and sometimes fun ways people invest in gold is to buy it in the physical form. This is generally done as bullion (i.e., gold bars) or coins of varying sizes.
Unlike stocks, crypto, or other assets, investors like this quality about gold because it gives them something tangible. They can see it, touch it, and freely trade it whenever the time is right.
However, holding gold in the physical form does present some challenges. For starters, it has to come from a reputable source to ensure its purity. Owners should also protect their gold by keeping it secure in a safe or an external safety deposit box.
One solution to both of these problems is to purchase gold from a dealer like Vaulted. Vaulted sells fine gold kilo bars which have a purity of 99.99 percent and are minted by the Royal Canadian Mint. Buyers can even choose to leave their gold in the security of the Mint if they’d rather not keep it at their residence.
Invest In Gold Funds
For investors who want the benefits of gold without actually owning it in the physical form, there’s a way to do this too. They can buy mutual funds or ETFs (exchange-traded funds) that are tied to gold’s over-the-counter gold market price.
One example of such a fund is the SPDR Gold Shares ETF (GLD). The trust that sponsors this fund is said to have gold bullion and cash to back it up at a rate of about one-tenth of an ounce of gold. However, investors cannot directly redeem their shares for physical gold.
Own Gold Mining Stocks
Another popular way to invest in gold is to buy the stocks of gold mining companies. The idea is that as the demand for gold rises, interest in these companies should also increase too.
However, investors need to be aware that by buying these stocks they are investing in a company rather than the actual gold market. This means that, in theory, a gold mining company could go into financial distress even though the price of gold is rising. However, it also means that a company could prosper even when the demand for gold is down.
Deciding Whether To Buy Gold Will Depend On You
There can be many good reasons for people to consider investing in gold. It can be used as a way to preserve wealth, hedge against inflation, and diversify your investment portfolio.
Many factors can affect the price of gold. A declining stock market, reduction in interest rates by the Federal Reserve, and the instability of other financial assets can all cause the price of an ounce of gold to rise.
Investors who want to add gold to their portfolios have several options. They can buy it in the physical form (through bullion or coins) or through mutual funds and ETFs. You can also invest in gold mining companies as an alternative way to benefit from interest in the market.
Ultimately, the decision of whether or not to invest in gold will depend on you and your goals. If you believe the future holds rising inflation, stock market uncertainty, or a fall in the price of Bitcoin, then gold may help to counterbalance your portfolio. Determine to what extent gold can protect your portfolio and invest accordingly.