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Whenever an economy is about to slip into recession, a period of high inflation, possible currency devaluation or massive political unrest, high net-worth individuals invest in gold. Why? Find out here.
Gold is a precious metal that has been desired by humans from the earliest era of civilization. Logical enough, that people started to invest in gold long ago and it’s now one of not only the earliest but also one of the most popular investment opportunities globally.
Similar to every other commodity with value sold in the market, gold has fluctuating prices based on its supply and corresponding demand. The major way gold is gotten is by extraction from hard rocks. However, there are other means of getting gold like the extensive processes involved in producing gold through placer mining or as a by-product of copper mining.
The biggest use of gold is in the fashion industry. It is used in the production of jewelry which is worn by the rich and wealthy in the society. There are other industries that extensively make use of gold, such as health, aviation, electronics, etc.
The entities that purchase gold the most are fashion brands, the government, and the reserve banks of varying nations. The country with the most gold in the world is the United States of America. For decades after the Great Depression of 1929, the U.S. bought up several amounts of gold from other countries and even from their citizens.
This has largely contributed to its massive storage of gold. Germany is the second nation with the highest amount of gold and the financial body, the International Monetary Fund (IMF) comes third. Gold is part of the currencies in the IMF’s basket for special drawing rights (SDR). Apart from international bodies and governments, individuals can also buy gold as a commodity. It is mostly viewed as a diversifying investment in portfolios.
Whenever an economy is about to slip into a recession of any kind, high net-worth individuals invest in gold. This is because while currencies depreciate in value with the aforementioned factors, gold doesn’t.
It is frequently said in the financial markets that history repeats itself. Many investors invest in gold because of its performance in the past years. The price of gold has enormously increased in the last 4 decades especially from 1978 to 1980 and 1999 to 2011. There have, however, been periods of stagnation for gold’s price as observed in the 1990s and the post-2011 era. The major reason gold massively increased in price during 1980 and 1999 was because of inflation fears.
Political uncertainty in the US after 9/11 and the Iraqi war also helped contribute to the boost in gold’s price. Recession and increased inflation were the motives behind the bullish move in gold’s charts. The bullish move was sustained because of numerous troubles in different economies all over the world. These troubles included the high inflation of the US dollar and the bearish outlook of Europe’s economy.
However, this great performance of gold’s price isn’t always consistent. When the outlook of an economy is solid, gold’s price practically remains stagnant against that currency, experiencing consolidating movements in price due to technical analyst traders. In the 1990s, gold’s price didn’t change much because of an increase in US gross domestic product.
The end of the bearish outlook on the US dollar following the global financial meltdown in 2011 drove gold from a sharp uptrend into a sustained downtrend and later a consolidating market. The strength of the stock market also had a negative effect on gold’s price as investors felt they’d hedged enough in gold and were ready to make a fortune from the stock exchange.
1. Gold Bullion
The gold bullion is the most popular type of possessing gold. Gold bullion can be described as gold that is totally or almost pure and has been attested for its mass and purity. The gold coin or bar would then be affixed with a serial number for identification.
Looking at heavy gold bars is a beautiful sight but they come with a slight ugliness to them; they’re highly illiquid and cannot easily be exchanged for cash. This is due to the expense of purchasing and selling gold. Gold bars are also somewhat indivisible, an important quality that is needed for liquid money. If you want gold bars that are easy to be bought and sold, you can go for intermediate or small sizes.
2. Gold Funds
Investors who strictly do not want to have gold in their possession usually invest in gold exchange-traded funds (ETFs) and mutual funds. This practically means they can take part in sharing gold profits without actually holding. An investor can purchase the shares of an ETF tracking gold. A single share equates to a certain quantity of gold.
Different brokers can help in the purchase of gold’s ETF shares since they’re traded on the stock exchange just like stocks. Investing in gold ETF is also beneficial to small investors in terms of risk reduction since the minimum buy-in is a single share of the ETF. The average ETF charges an expense ratio of 0.44% annually which covers their transaction costs.
Some mutual funds possess gold in bulk in the quest to diversify their portfolio. However, a very small number of mutual funds invest only in gold. Funds like ETFs only track the indexes of gold mining companies and thus charge lower expense ratios to mutual funds. Most gold investors, however, prefer to invest in gold ETFs and gold mutual funds as an alternative to purchasing gold bars.
3. Gold Futures and Options
A future can be described as an agreement to purchase or make a sale of a commodity at a certain date and time in the future. Gold futures are considered contracts and also represent a fixed amount of gold. This method of investing in gold is similar to the margin trading of cryptocurrencies.
To purchase gold futures, the investor has to open an account with a reputable broker and deposit the minimum amount required (most times in USD or the local currency) by the broker. This is the minimum amount required to open a position on the exchange – usually referred to as the initial margin.
In layman terms, trading gold futures involves opening a position at a price and predicting the direction gold will move. If the price of gold goes in the direction predicted by the trader, then profit is made, otherwise, the trade results in a loss. After a certain number of trades, if the account balance of the investor falls below the maintenance margin, the trader would be required to deposit some more money in order to get your account balance to be at par with the initial margin.
On the delivery option, quite a number of brokers do not have this so when the contract expires, it is then settled in cash. The investors, when trading gold futures should have this in mind and set the expiration of the contract in accordance with the time required for their trade to yield some profit.
The market is said to be in contango when the price of earlier expiry futures and spot prices are lower than the prices of later expiry contracts. Purchasing gold futures under this condition will require a payment on premium for later expiry contracts. When reverse is the case, the market is said to be in backwardation.
Gold options, on the other hand, are an alternative to the outright purchase of futures contracts. Instead of the variability in price at any point when the investor chooses to buy a futures contract, options afford the investor the opportunity to purchase the futures contract at a fixed price and during a particular period.
One advantage of options is that despite the fact that it leverages the initial deposit, it limits the losses to the initial investment. Futures contract as mentioned earlier can incur losses that are greater than the initial investment provided the losses are huge and sequential.
Investing in options, however, has its downside. Futures contracts allow the investor to purchase gold at its current value but the case is not the same for options. The investors would be required to pay a premium based on gold’s market value in order to purchase the contract at the preset price and period.
Gold is a commodity and obviously obeys the law of supply and demand. Since it is also traded in financial markets, it is also subject to price actions and the behavior of investors. Gold is however not subject to inflation as proven by economists.
Their studies show that unlike fiat currency which experiences inflation as more are printed into circulation, the supply of gold is constant and its mining output doesn’t do much to its price. Statistics from the Great Recession and further studies show that fear is what drives the price of gold most times as investors run to gold when an economic crisis hits.
Since gold isn’t consumed like oil or coffee, how then does inflation not hit gold? The answer is simple, the jewelry or asset carved out from gold ends up in some drawer somewhere, on a person or in some home. Pretty much all the gold that has ever been mined is still somewhere on the earth and the demand for the luxury that comes with gold items has never declined.
The central banks are also a driving factor behind the price of gold especially when the forex reserves are getting full. The central bank then begins disposing of some of its gold since it is a dead asset and generates no return for the economy.