Why Invest In Gold?

Gold is an attractive yellow metal that comes with several qualities that make it precious. It has been used as a means of trade and as jewelry for thousands of years. It is the most malleable and ductile metal, which doesn’t oxidize in air or water. Gold is resistant to corrosion and can be alloyed with metals to make it stronger. It has a melting point of 1947.2°F. Gold purity is measured in karats (k) with pure gold being 24k and its weight is valued in troy ounces (oz t). One troy ounce which is approximately 31.1 grams. Although many people associate gold with jewelry, it is a vital component of many industrial processes especially due to its conductivity. As an investment, it has been held by nations and individuals as a measure of wealth. Over time gold has proven to be one of the most stable and profitable investments.

Occurrence

To date, between 140,000 and 170,000 tonnes of gold have been mined across the globe. South Africa is one of the largest exporters of gold in the world with other countries such as Australia, China, Russia, Peru, and the USA also having large scale gold deposits. Over one-quarter of the world gold output is estimated to originate from small scale mining.

Gold as money

Traditionally countries and regions have minted coins made of gold and other precious metals and until recently it has been used as a standard for currency. However, instead of carrying bulky gold and silver coins, banks and custodians have issued paper receipts for stored precious metals. These receipts or certificates have been traded between buyers and sellers for goods and services have resulted in the transition to the modern fiat currency system. The Swiss Franc was the last currency to be divorced from gold in 2000. Although every currency around the world is now just paper or digital entries in a computer, there have been calls recently for a return to a gold standard with a new global currency backed by gold. Since gold is a symbol for value and purity, many governments have recently been exchanging goods and services for physical gold bullion.

Influencing factors

The value of gold is influenced by speculation as well as supply and demand. However, the price is affected mainly by changes in demand rather than in supply. Annual production is equivalent to around 1.5% of the total quantity of gold stored above ground at around 2,500 tonnes per year. Approximately 20% of production is sent to investors and into exchange traded gold derivatives. The remaining production goes into jewelry, industrial and dental production. The price of oil and other commodities are also closely related to gold price. There are other factors that influence the price of gold:

  • Central banks: The price of gold is influenced greatly by Central Banks since they hold approximately 20% of all official reserves of gold above ground. Recently members of the BRICS group of emerging industrial nations such as China, Russia and India have announced they are buying physical gold.
  • Interest rates: Interest rates also affect the price of gold. When Central banks raise interest rates the price of gold falls and when the rates fall, the price of gold rises. Depending on whether investors believe there is a possibility of a longer period of inflation the price of gold could rise if interest rates rise.
  • Hedge against inflation: Inflation is a general increase in prices and a fall in the purchasing value of currency. Gold has historically been used as a hedge against inflation, deflation or currency devaluation. This means that the price of gold will rise in times of uncertainty and fall in times of confidence.
  • Jewelry: Jewelry takes up approximately two thirds of the annual demand for gold with India and China being the largest consumers due to the expansion of the middle classes aspiring to Western lifestyles.
  • Industry: Gold has many kinds of industrial uses including gold solder in jewelry, gold thread in embroidery, photography, heat shielding on satellites and in automobiles, reflective layer on high end CDs and even be pressed so thin that it's virtually invisible and used to line aircraft cockpit windows and astronauts' helmets.
  • Electronics: Gold is an efficient conductor of electricity with the added benefit of being resistant to corrosion. Electronic components made with gold are very reliable. Its common to find gold used in connectors, switches, soldered joints and in connecting wires and strips. Gold has been found in computers, cell phones, calculators, PDA's, GPS systems and televisions.
  • Medicine & Dentistry: In dentistry gold is largely used for crowns, fillings and permanent bridges. Colloidal gold, which uses gold nanoparticles, is used in research applications in biology and medicine.

Investment vehicles

There are many different forms of gold that you can invest in, including:

Gold bars

Bullion bars are the most traditional way of investing in gold. Bullion dealers and some major banks in most countries will buy and sell gold bullion bars in various sizes. The most common sizes of gold bullion are: 400 troy ounce bars, 100oz, 32oz (1kg), 20oz, 10oz, 50gm, 1oz, 20gm, 1/2oz, 10gm, 1/10oz, 1/20oz, 2.5gm and 1gm.

If you choose to invest in gold bars, it is advisable to have every bar assayed. This is due to the simple reason that bars are easier to forge than coins and as a result have carried less value. Recently India has found gold plated tungsten bars in shipments of gold bullion and therefore it is important to purchase gold bars that have a verifiable chain of custody that can be traded from refiner, to assayer and then to vault. Other ways to combat counterfeiting include the use of unique holographic technology.

Gold coins

There are two kinds of gold coins; bullion and numismatic. The price of bullion coins is determined by their fine weight and a small premium based on supply and demand. Numismatic gold coins are priced according to rarity and condition. Bullion coins are a more common form of investment. In the USA there is a wide selection of government-backed bullion that meets the IRA-required purity standards for use in individual retirement accounts. Aside from traditional gold American Eagle bullion coins, eligible gold bullion includes legal tender gold coins with at least .995-fineness such as: gold Maple Leaf bullion coins, gold Philharmonic bullion coins, and others of varying weights.

Although it is easier to spot fakes in coins than in bars, there are still a lot of fake coins in circulation that are usually made of gold-plated lead.

Exchange-Traded Products (ETP's)

These offer investors a way to invest in gold without the inconvenience of storing physical gold bullion coins and bars. They come in different forms, including: Exchange-Traded Funds (ETF's), which is a mutual fund that is traded on a stock exchange; Exchange-Traded Notes (ETN's), which is more like a bond; and Closed-End Funds (CEF's), which is more like a stock. These paper based investment products usually hold the physical gold for the benefit of the investor, however they have been criticized due to their complexity and similarity to mortgage-backed securities.

Certificates

There are two types of gold certificate, one is allocated (reserved) and the other is unallocated (pooled). Unallocated certificates are a form of fractional reserve banking and do not guarantee an equal exchange of physical gold due to asset forfeiture or bankruptcy of the custodian. Allocated certificates are correlated with specific bars and therefore investors are guaranteed equal exchange. The first paper currency were gold certificates and were used by goldsmiths for customers keeping gold in their vaults for safe-keeping.

Accounts

Gold accounts such as those used by digital currency systems can be bought or sold instantly just like any foreign currency and gold can be transferred between members of the service. Similar to gold certificates they can be pooled or reserved.

Derivatives, Contracts For Difference and Spread Betting

Many stock exchanges around the world offer derivatives, which are financial products (such as a forward, future or option) whose value derives from and is dependent on the value of an underlying asset, index or security. Gold Forwards, Gold can be paid for at a specific time in the future at today's pre-determined price. Gold Futures: are contracts to buy or sell gold on or before a future date at a price specified today. Gold Options: are contracts to give the owner the right, but not the obligation, to buy or sell gold. These investments come with some risk, since it is seen to be a form of betting.

Conclusion

Gold is one of the most stable forms of investment in the financial markets today. While it is true that its value is affected by inflation, interest rates as well as supply and demand it makes sense for people who have varied portfolios to include gold among their investments. It is better to purchase and store physical gold bullion coins and bars than to invest in paper financial instruments since it has been claimed there is currently a ratio of between 100 to 400 paper gold contracts to every physical gold contract and that physical gold warehouses are no longer guaranteeing their inventory counts. If an economic crisis were to occur, you are much better off holding physical gold than any kind of paper investment.