Gold as an investment

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Reserves of foreign exchange and gold

Of all the precious metals, gold is the most popular as an investment. Investors generally buy gold as a hedge or safe haven against any economic, political, social, or currency-based crises. These crises include investment market declines, inflation, war, and social unrest. Investors also buy gold during times of a bull market to gain financially.


[edit] Gold price

Gold price in US Dollars 1968 — 2008.

Throughout history gold has often been used as money and, instead of quoting the gold price, all other commodities were measured in gold. After World War II a gold standard was established following the 1946 Bretton Woods conference, fixing the gold price at $35 per troy ounce.

The system held up until 1971 Nixon Shock, when the US stopped the direct convertibility of the United States dollar to gold. Since 1968 the usual benchmark for the price of gold is known as the London Gold Fixing, a twice-daily (telephone) meeting of representatives from five bullion-trading firms. Furthermore, there is active gold trading based on the intra-day spot price, derived from gold-trading markets around the world as they open and close throughout the day. The following table sets forth the gold price versus various assets and key statistics:

Year Gold, USD/oz[1] Silver, USD/oz[2] DJIA, USD[3] World GDP, USD tn[4] US Debt, USD bn[5]
1970 37.4 1.6 838.9 3.3 370.1
1975 140.3 4.2 852.4 6.4 533.2
1980 589.5 15.5 964.0 11.8 907.7
1985 327.0 5.8 1,546.7 13.0 1,823.1
1990 353.4 4.2 2,633.7 22.2 3,233.3
1995 369.6 5.1 5,117.1 29.8 4,974.0
2000 272.7 4.6 10,786.9 31.9 5,662.2
2005 513.0 8.8 10,717.5 45.1 8,170.4
2008 865.0 10.8 8,776.4 54.6 10,699.8

In March 2008 the gold price reached above $1000[6], reaching an all-time nominal high of $1002.80 which, in real terms was still well below the $850 peak in 1980. It then fell, going as low as $709.50 in November, then resumed its upward trend, temporarily breaking the $1000 barrier again in late February 2009.

[edit] Factors influencing the gold price

Today, like all investments and commodities, the price of gold is ultimately driven by supply and demand. Unlike most other commodities, the hoarding and disposal plays a much bigger role in affecting the price, because most of the gold ever mined still exists and is potentially able to come on to the market for the right price.[7][8] Given the huge quantity of stored gold, compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production.[9] According to the World Gold Council, annual mine production of gold over the last few years has been close to 2,500 tonnes.[10] About 2,000 tonnes goes into jewelry or industrial/dental production, and around 500 tonnes goes to retail investors and exchange traded gold funds.[10] This translates to an annual demand for gold to be 1000 tonnes in excess over mine production which has come from central bank sales and other disposal.[10]

Central banks and the International Monetary Fund play an important role in the gold price. At the end of 2004 central banks and official organizations held 19 percent of all above-ground gold as official gold reserves[11]. The Washington Agreement on Gold (WAG), which dates from September 1999, limits gold sales by its members (Europe, United States, Japan, Australia, Bank for International Settlements and the International Monetary Fund) to less than 400 tonnes a year[12]. European central banks, such as the Bank of England and Swiss National Bank, have been key sellers of gold over this period[13]. Although central banks do not generally announce gold purchases in advance, some, such as Russia, have expressed interest in growing their gold reserves again as of late 2005[14]. In early 2006, China, which only holds 1.3% of its reserves in gold[15], announced that it was looking for ways to improve the returns on its official reserves. Some bulls hope that this signals that China might reposition more of its holdings into gold in line with other Central Banks.[16]

A 500,000,000,000 (500 billion) Yugoslavia dinar banknote circa 1993, the largest nominal value ever officially printed in Yugoslavia, the final result of hyperinflation. Photo courtesy of National Bank of Serbia.
Bank failures
When dollars were fully convertible into gold, both were regarded as money. However, most people preferred to carry around paper banknotes rather than the somewhat heavier and less divisible gold coins. If people feared their bank would fail, a bank run might have been the result. This is what happened in the USA during the Great Depression of the 1930s, leading President Roosevelt to impose a national emergency and to outlaw the hoarding of gold by US citizens.[17] known as Executive Order 6102 which has since been ended.
Low or negative real interest rates
If the return on bonds, equities and real estate is not adequately compensating for risk and inflation then the demand for gold and other alternative investments such as commodities increases. An example of this is the period of Stagflation that occurred during the 1970s and which led to an economic bubble forming in precious metals.[18][19]
War, invasion, looting, crisis
In times of national crisis, people fear that their assets may be seized and that the currency may become worthless. They see gold as a solid asset which will always buy food or transportation. Thus in times of great uncertainty, particularly when war is feared, the demand for gold rises.[20][21]
The Gold Anti-Trust Action Committee
Organized in January 1999 to advocate and undertake litigation against illegal collusion to control the price and supply of gold and related financial securities.[22] They argue that there could be no US gold in the Fort Knox.[23]

[edit] Reasons investors buy gold

Investors generally buy gold for two main reasons: to financially gain from increasing gold prices, and/or as a hedge or safe haven against any economic, political, social or currency-based crises.

[edit] Methods of investing in gold

Investment in gold can be done directly through bullion or coin ownership, or indirectly through gold exchange-traded funds, certificates, accounts, spread betting, derivatives or shares.

[edit] Investment strategies

[edit] Fundamental analysis

One troy ounce along with the certificate

Investors using fundamental analysis analyze the macroeconomic situation, which includes international economic indicators, such as GDP growth rates, inflation, interest rates, productivity and energy prices. They would also analyze the yearly global gold supply versus demand. Over 2005 the World Gold Council estimated yearly global gold supply to be 3,859 tonnes and demand to be 3,754 tonnes, giving a surplus of 105 tonnes.[24] While gold production is unlikely to change in the near future, supply and demand due to private ownership is highly liquid and subject to rapid changes. This makes gold very different from almost every other commodity.[7][8]

[edit] Gold versus stocks

Dow/Gold Ratio 1968-2008

The performance of gold bullion is often compared to stocks. They are fundamentally different asset classes. Gold is regarded by some as a store of value (without growth) whereas stocks are regarded as a return on value (i.e. growth due to anticipated real price increase plus dividends). Stocks and bonds perform best in a stable political climate with strong property rights and little turmoil. The attached graph shows the value of Dow Jones Industrial Average divided by the price of an ounce of gold. Since 1800, stocks have consistently gained value in comparison to gold due in part to the stability of the American political system.[25] This appreciation has been cyclical with long periods of stock outperformance followed by long periods of gold outperformance. The Dow Industrials bottomed out a ratio of 1:1 with gold during 1980 (the end of the 1970s bear market) and proceeded to post gains throughout the 1980s and 1990s. The peak of 1980 also coincided with the Soviet Union's invasion of Afghanistan and the threat of the global expansion of communism. The ratio peaked on January 14, 2000 a value of 41.3 and has fallen sharply since.

In November 2005, Rick Munarriz of Motley posed the question of which represented a better investment: a share of Google or an ounce of gold. The specific comparison between these two very different investments seems to have captured the imagination of many in the investment community and is serving to crystallize the broader debate.[26][27] At the time of writing, a share of Google's stock and an ounce of gold were both near $700. On January 4, 2008 23:58 New York Time, it was reported that an ounce of gold outpaced the share price of Google by 30.77%, with gold closing at $859.19 per ounce and a share of Google closing at $657 on U.S. market exchanges. On January 24 2008, the gold price broke the $900 mark per ounce for the first time. The price of gold topped $1,000 an ounce for the first time ever on March 13, 2008 amid recession fears in the United States.[28] Google closed 2008 at $307.65 while gold closed the year at $866.

[edit] Technical analysis

As with stocks, gold investors may base their investment decision partly on, or solely on, technical analysis. Typically, this involves analyzing chart patterns, moving averages, market trends and/or the economic cycle in order to speculate on the future price.

[edit] Using leverage

Bullish investors may choose to leverage their position by borrowing money against their existing gold assets and then purchasing more gold on account with the loaned funds. This technique is referred to as a carry trade. Leverage is also an integral part of buying gold derivatives and unhedged gold mining company shares (see gold mining companies). Leverage via carry trades or derivatives may increase investment gains but also increases risk, as if the gold price decreases, the investor may be subject to a margin call.

In 2008, ETF Securities launched ETFS Leveraged Gold (LSELBUL) which is designed to change each day by twice the daily percentage change in the DJ-AIG Gold Sub-Index (before fees and adjustments). Therefore if the DJ-AIG Gold Sub-Index rises (or falls) by 1% in one day, then ETFS Leveraged Gold will rise (or fall) by 2%.

[edit] Bulls versus bears

Since April 2001 the gold price has more than tripled in value against the US dollar, prompting speculation that the long secular bear market (or the Great Commodities Depression) has ended and a bull market has returned[29]. A World Gold Council report released on February 18, 2009 showed physical gold demand rose sharply in the second half of 2008. Identifiable investment demand for gold, which includes ETFs (exchange-traded funds), bars, and coins, was up 64 percent in 2008 over the year before.[30]

In the last century, major economic crises (such as the Great Depression, World War II, the first and second oil crisis) lowered the Dow/Gold ratio, an indicator of how bad a recession is and whether the outlook is deteriorating or improving, to a value well below 4. The ratio fell on February 18, 2009 to below 8. [31] During these difficult times, investors tried to preserve their assets by investing in precious metals, most notably gold and silver.

[edit] References

  1. ^ LBMA Gold Fixings yearly close
  2. ^ LBMA Silver Fixings yearly close
  3. ^ Dow Jones Industrial Average yearly close
  4. ^ The UN Statistics Division world GDP
  5. ^ Historical Debt Outstanding - Annual 1950 - 1999, The Debt to the Penny and Who Holds It
  6. ^ 2008 London Gold Fixings
  7. ^ a b Howstuffwo678rks "All the gold in the world"
  8. ^ a b World Gold Council > value > market intelligence > supply & demand > recycled gold
  9. ^ World Gold Council > discover > gold knowledge > frequently asked questions
  10. ^ a b c Please login to download > World Gold Council, the information resource for gold, investment, jewellery, science and technology, historical and culture > Please login to download
  11. ^ Official gold reserves
  12. ^ 400 tonnes/year
  13. ^ UK Treasury & Central Bank Gold Sales
  14. ^ Russia
  15. ^ A Gold Play on the Dollar's Demise Seeking Alpha
  16. ^ Dollar, gold see sharp moves on China's diversification talk - MarketWatch
  17. ^ The Roosevelt Gold Confiscation Order Of April 3 1933.
  18. ^ Rogers, Jim (2004). Hot Commodities : How Anyone Can Invest Profitably in the World's Best Market. New York: Random House. ISBN 1-4000-6337-X. OCLC 56559347. [page needed]
  19. ^ Wiggin, Addison; Justice Litle (2006). Gold: The Once and Future Money. New York: Wiley. ISBN 0-470-04766-6. OCLC 70173338. [page needed]
  20. ^ London Stock Exchange - Article
  21. ^
  22. ^ GATA Official Web-site
  23. ^ TIMES: Is there any gold inside Fort Knox, the world's most secure vault?
  24. ^
  25. ^ Investments (7th Ed) by Bodie, Kane and Marcus, P.570-571
  26. ^
  27. ^*
  28. ^ Gold, oil reach highs amid U.S. recession fears
  29. ^ Gold starts 2006 well, but this is not a 25-year high! | Financial Planning
  30. ^
  31. ^

[edit] See also

[edit] External links

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