Why Investing In Gold Is Good Idea
Gold is perhaps the single physical asset that people all over the world hold in the highest regard. Gold has been interwoven in the cultures of many people around the world. Gold coins appeared as early as 800 B.C and have continued to be used as major trading commodity or simply to preserve wealth down the centuries.
You might still wonder why invest in gold while there are hundreds of other investable commodities in the market, many of which are perhaps more liquid than gold itself. There are several reasons why investing in gold is a good idea.
Weakness of the Dollar
The U.S. dollar is the most important reserve currency in the world; when the value of the dollar declines against the world’s major currencies as happened between 1998 and 2008, people flock to gold, and consequently, the prices skyrocket. Gold prices nearly tripled between 1998 and 2008, hitting the psychological $1,000 per ounce mark in early 2008. The price action continued unabated between 2008 and 2012 with prices again almost doubling to $1,800-$1,900 per ounce. The devaluation of the dollar was triggered by a variety of factors such as major trade deficits and increased money supply.
Price & Demand Mechanics
Gold is usually priced below its margin cost of production and near its average cost of production. Gold fundamentals are, therefore, reason enough to buy the precious metal. One of the most basic rules of investment is buying assets below their replacement value. Gold is currently trading around its cost of incremental production.
Since the escalation in gold price over the last decade, mining companies have scrambled to produce more. The incremental production costs for many mines is above $1,300. The rising cost is very likely to keep production depressed.
Meanwhile, there is increased demand for gold in the emerging markets such as China and India. India is one of the world’s largest gold consumers, especially due to high demand for gold jewelry which is used extensively in wedding ceremonies. The Chinese use gold bars a lot as a popular mode of saving.
Locally, many investors view gold as an investment class. The SPDR Gold Trust has consequently become one of the largest ETFs (exchange-traded funds) in the U.S., and one of the world’s largest holders of gold bullion.
The interplay between low production and high demand is likely to keep gold prices high.
If you are a value investor or contrarian investor you are probably aware that stocks of mining companies are currently rated as some of the most undervalued in the market today. The overall market is currently trading at historic highs and finding value stocks is not easy.
Many mining stocks have generally been selling off and several are currently selling below their fair value. Value stocks are most likely to hold up well during a market downturn than the average stock. Gold is one of the few commodities whose price is easily driven by politics rather than economic activity. Political uncertainties are likely to drive up the price of the metal.
For an investor’s portfolio to be properly diversified, it should ideally be at least party invested in gold. 2% or 3% of your portfolio invested in gold at the very least would be okay for a start. Many investors have had their fingers burnt due to lack of enough diversification. The main key to diversification lies in finding instruments that are not closely correlated. Gold has historically had a negative correlation to other financial instruments. For instance, the 70s were great years for gold but really bad for other stocks. In the 80s, the trend reversed as stocks soared while gold lagged. Consumers have been migrating into gold since 2008 which has driven gold prices up. With the U.S. stock market trading at all-time highs, chances of a major market correction are quite high. Expect prices to soar in return.
Hedging Against Inflation
Gold has historically been used as an effective hedge against inflation, because its prices tend to rise when the cost of living rises. The five years when inflation in the U.S. was at its highest are 1946, 1974, 1975, 1979, and 1980. The average real return of gold during those years was 130.4% compared to -12.33% for the Dow Jones Industrial Average.
Ways to Invest In Gold
There are several ways you can take advantage of gold’s time-proven ability to preserve wealth and retain value. You can buy gold coins or bars. These are more liquid than other gold assets and their value is much easier to gauge as well. You can also rollover your IRA to physical gold to protect your retirement fund against inflation.
Gold coins generally sell at higher prices than the spot value of gold mainly due to their design and manufacturing costs. Their upside, however, is that they are more liquid than gold bars and can easily be bought and sold. Gold bars sell near gold spot price since they are easier to produce and store. They are available in various sizes such as 1-once, 400-ounces, and 1kg.
If you do not like the idea of buying physical gold, you can invest in exchange-traded funds (ETFs). Make sure the ETF you invest in holds physical gold as the primary investment.