Gold is one of the most important commodities in the financial system. It is a precious metal that is beloved by central banks, institutional, and retail investors. Most notably, it is one of the most traditional assets that has been valuable for millennia and its importance is expected to continue over time. Gold is loved for its prestige and the fact that it is a good hedge against inflation.
What is gold used for?
Gold is a precious metal that has limited industrial usage. This fact makes it different from other industrial metals like copper, zinc, and aluminium. The most important industrial usage of gold is in the manufacture of jewellery, medals, and coins. Still, these uses account for less than 5% of all gold that is mined today.
Instead, gold is used as an investment asset. Central banks like those in Russia, the United States, the United Kingdom, and China actively buy gold from mining companies and store them as reserves. The Federal Reserve has more than 261 million of gold in its reserves. Going by the current prices, this gold is worth about $12 billion.
China’s gold reserves have been on an upward trend over the years. It is estimated that the country holds more than 1,957 tons of gold in its reserves. These reserves have grown in the past 15 consecutive years. Russia is another major buyer of gold. It owns more than 2,257 tons of gold in its reserves.
Countries own gold as a way of diversifying their returns. Countries like Russia and China hold these reserves to diversify their reserves from fiat currencies like the US dollar and the euro.
Gold is also used by investors to hedge against inflation and diversify their returns. Some investors own physical gold while most of them hold the metal in form of Exchange-Traded Funds (ETFs). The biggest gold ETF is the iShares Gold Trust that has more than 15 million ounces in custody. The net assets in the fund are worth more than $28 billion. There are other ETFs that track gold mining companies.
Gold has other uses in the industrial sector. For example, jewelry companies use gold to manufacture their most premium pieces, It is also used to manufacture medals, which are awarded in key events. Also, it has some uses in the space and dentistry industry. Still, these industrial uses have a little impact in determining the price of gold.
Why invest in gold?
There are several reasons why you should invest in gold for the long term. First, gold is an excellent asset you can use to diversify your portfolio returns. For one, it offers uncorrelated returns from other assets like stocks, art, and real estate.
If you have a basket of investments, gold will always be a good way to diversify your returns. Experts believe that a portfolio should have a mix of assets like stocks, bonds, precious metals, indices, and even cryptocurrencies. As such, an asset like gold will help to provide a hedge if the prices of other assets decline.
Second, gold has a long track record of being a hedge against inflation since its price tends to increase over time. In the past few years, inflation in the United States has been rising substantially. This means that the value of a fiat currency like the US dollar has been dropping.
In November of 2021, the US inflation surged to a 32-year high of 6.8%. This growth was attributed to the ongoing supply chain disruptions, high energy prices, and lax policies by the Federal Reserve.
Therefore, if you had dollars in your bank account in the past decades, the purchasing power has declined substantially. For example, according to the US inflation calculator, if you bought something for $100 in 1975, you would buy the same item for about $516 today.
On the other hand, the average price of gold in 1975 was about $135. At the time of writing, gold was trading at $1,783. This means that you would have realized returns of more than 1,220% in the same period.
Unfortunately, the US dollar is expected to keep losing its value over time. For one, the Federal Reserve has embraced a program known as quantitative easing (QE) that is increasing the amount of dollars in circulation. The bank has grown its balance sheet from less than $1 trillion in 2008 to almost $9 trillion.
The Fed will also keep doing that because of the widening budget deficit in the US. The deficit has been growing since 2001, the last year that the government had a surplus. With social and infrastructure spending rising, the Fed will likely keep printing money to support the government.
Third, unlike fiat currencies, gold has a finite supply. As mentioned, the Fed and other central banks can come up with an unlimited amount of money. The situation is different for gold, a metal that is mined from deep beneath the earth’s crust.
Gold mining companies are still sitting on tons of supplies that they have not mined. However, over the years, this supply will either run out or reach a point where it is not economically viable to mine it. It is still unclear when that will happen but some analysts expect that it will be about 2050. Therefore, there is a likelihood that gold will be more valuable as its supplies deteroriate.
Fourth, while gold is a good hedge against inflation, it is also a good hedge against deflation. Deflation is defined as a period when the price of items in a country is falling. The US has not gone through deflation recently but some countries have. For example, in Japan, the prices of most items has rarely changed over the years. Therefore, people in Japan who bought gold a few years ago have seen better returns.
How to invest in gold
There are several ways of investing in gold. First, the easiest method is to invest in gold that has been securitized such as through an exchange-traded fund (ETF). The process of doing this is relatively simple.
All you need is a brokerage account and some cash. The benefit of investing in a gold ETF is that there are no commissions charged. Also, it is a relatively safe option since a mutual fund cannot be stolen. Most importantly, it is a relatively liquid option meaning that you can buy and sell the asset at any time.
Second, you can invest in gold by buying coins. There are many companies that sell gold coins in the US. Over time, the value of some rare coins has exceeded that of normal gold. There is a risk of where to store the metal. Also, there are security risks involved.
Third, you can invest indirectly by holding shares of gold mining companies. Still, over the years, there is usually a divergence between the price of gold and mining stocks.
Gold has an unblemished track record for millennia. Its use as a precious metal can be tracked in most ancient books. And there is a likelihood that the metal’s price will keep rising over the years as the value of fiat currencies drop. In this article, we have looked at several reasons for investing in gold and ways of doing so.