Gold As A Store of Wealth
Gold has been used as a store of value for almost all of recorded history. Due to its scarcity, it’s portability, and its esthetic appeal, it has always been desirable as currency and for investment purposes, and this remains to be fully the case today.
Like other metals, gold is not mined out of the ground in its pure state, and must be refined to various levels of purity. In order for it to be used as a mechanism of exchange, it is desirable to standardize it, and this is going to involve minimum levels of purity.
Gold is used for several purposes other than for investment, for instance a lot of gold is crafted into jewelry, combined with other alloys to give it more durability. Pure gold is rather soft as metals go, a quality that makes it easy to work with, but does not meet the standards of wear and tear that jewelry demands.
Much of newly mined gold is used in making electronics, and gold is an excellent conductor, especially in more humid conditions that some electronics are subject to, such as cell phones. About 10% of all newly mined gold is used for this purpose.
Most gold though goes to the market as bars, called gold bullion, and is generally 99.99 percent pure.
Gold has been typically been held as a store of value by central banks to support their currencies, giving them actual physical value, at a time where people were more skeptical of fiat currencies, paper which simply has a value by way of a government’s declaration. We’ve moved away from that though and fiat money now inspires enough confidence that backing it with gold is no longer needed, and this is very inefficient as well.
If one is to trade in gold, it is necessary that one know the purity of the gold, otherwise the quality of it is unclear. Gold is therefore subject to assay, with its purity being stamped upon it, as a percentage of pure gold.
Gold may also serve as legal tender, and this has been the case throughout the ages, although the face value of gold coins today are of a much lower value than the face value, so these coins are not used as money, although they could be if one wished to. Anyone would gladly accept a gold coin with a face value of $50 for instance which consisted of an ounce of fine gold, worth many times more than that.
Having gold coins be legal tender, issued by governments, does add legitimacy to them though, and all of the world’s gold coins that are traded are created by government owned mints, such as the United States, Canada, Australia, China, and others. These are deemed to be bullion coins from meeting the minimum standards of purity that bullion signifies.
The Two Main Types of Investment Grade Physical Gold
Gold coins are a market unto themselves though, and aren’t traded as commodities. This means that each type is traded individually, and may actually have different standards of purity over and above the minimum standard. So the price for them may vary depending on this and also depending on the demand for them and the added costs of trading and storage along with dealer profit.
Gold as a commodity though is traded in bars or ingots, by the ounce, and is generally traded in 100 ounce lots. Gold bars can be bought in many different sizes though, as small as a single gram. One may buy gold on the open market for immediate delivery, called the spot market, or one may trade gold on the futures market, buying or selling contracts of 100 troy ounces of it to be delivered at a date in the future for an agreed upon price.
For a number of years, it wasn’t lawful in the United States to own physical gold, but this has since been repealed. This was back in the days when the U.S. was on the gold standard and required a certain amount of gold in reserve to back their currency, to print more money in other words, but this is no longer required.
Individual investors buy gold from dealers, as they do not have the means to trade for it on their own in gold spot markets, and this is the case with investments generally, where they are bought and sold through a market intermediary, such as a broker.
Intermediaries also provide delivery and storage services, as well as providing security and insurance against loss. One may also take physical delivery of the gold themselves, but given its high value, many investors prefer to have it stored elsewhere, especially if the amount of gold held is significant.
It is estimated that about $125 billion dollars worth of gold is traded each and every day. This is a huge amount and provides a tremendous amount of liquidity for those who are looking to buy and sell gold.
The worldwide stock market, by comparison, trades over $300 billion worth of stock each day, but this is spread among thousands of stocks. Gold is a single entity though as it is a commodity and all of the buying and selling of gold bullion that takes place on financial markets involves this single commodity, so the sheer volume of gold trading surpasses everything else in the market by a long shot, save for the largest currencies such as the US Dollar or Euro, which trade in volumes several times larger than anything else does.
Gold As The Ultimate Financial Hedge
Gold is not only desirable as in investment in itself, it also serves as a hedge for other financial investments, such as securities. Because investors who flee the stock and even the bond market so often take up bigger positions in gold, the demand for gold tends to maintain an inverse relationship with financial securities.
So in times of market pullbacks, the price of gold will go up. So if you expect such an event, you may invest in gold to speculate on these downturns. People may also invest in gold for its tendency to appreciate in value over time.
Gold as an investment can run pretty flat for a very long period of time though, so if one is looking to invest in it for its long term value, one must be aware that the desirable time frames for this may be measured in decades. For instance, between 1980 and 2000, gold declined in value, even though it is higher than peak 1980 levels today.
Since 2001 the gold market has been mostly bullish though, although it is prone to trading frenzies that can quickly turn the other way and result in big movements down as well. This has happened recently in the run up caused by what has been called the big recession and has lost about a third of its value off of the peak.
Negative market conditions make the timing of gold trading much easier though, as these rises are much more predictable and sustained. This recent recession is a perfect example of this, where prices tripled over the next few years, as more and more people jumped on the bandwagon.
Gold serving as a hedge though, where one holds it as protection against negative market forces, adds a lot of stability to the price of gold, as this is what keeps things from being even more skewed towards bear and bull markets.
If everyone just got out of gold and moved to stocks for instance during bull markets, this would depress the price of gold much more severely than it is already subject to, but much gold is held as a hedge to help take the edge off the risk of positions in securities.
How this works is that if one has a position in gold as well as in securities, the securities hedge the gold, and even more significant, the gold hedges the securities. So if you are down money in the market, this means that you’ve probably made money on your gold investments, and this helps cushion the blow. When we use such a strategy in advance, for protection so to speak, this is called hedging risk.
Other Investments Based Upon Gold
Given the popularity of gold as an investment, there are a number of ways that you can invest in it besides buying physical gold.
One may trade gold futures or options on futures, and both of these strategies need not even involve ever taking possession of the gold as you would buying it from a dealer who buys it on the spot market, as one may trade in these derivatives merely to speculate on price movements.
So if you expect the price of gold to go up or go down, you can buy gold, or you can further leverage your exposure by buying futures or options on gold contracts. This magnifies your wins and losses if you are right or wrong versus trading in gold itself.
This is especially the case with options, which are riskier than futures, and you can make a lot of money if you’re right, and lose up to your entire investment if you are wrong. Options themselves can be a hedge though, and you can even hedge your gold positions with futures and options, where if the price doesn’t go your way, the value of the futures and options runs the other way, and will limit your losses and therefore your risk exposure.
One may also invest in gold based mutual funds and exchange traded funds or ETFs, which may hold a variety of gold based assets, including physical gold, gold futures, gold options, as well as stock in gold mining companies, which are also sensitive to the price of gold.
However you choose to invest in the gold market, it does play a significant role in the world economy, as it has done the dawn of financial trading, and is well worth considering in various circumstances.