1. Weakness of the U.S. DollarAlthough the U.S. dollar is one of the world's most important reserve currencies, when the value of the dollar falls against other currencies as it did between 1998 and 2008, this often prompts people to flock to the security of gold,
which raises gold prices. The price of gold nearly tripled between 1998
and 2008, reaching the $1,000-an-ounce milestone in early 2008 and
nearly doubling between 2008 and 2012, hitting around the $1800-$1900
mark. The decline in the U.S. dollar occurred for a number of reasons,
including the country's large budget and trade deficits and a large increase in the money supply.
2. A History of Holding Its ValueUnlike paper
currency, coins or other assets, gold has maintained its value
throughout the ages. People see gold as a way to pass on and preserve
their wealth from one generation to the next.
3. InflationGold has historically been an excellent hedge against inflation,
because its price tends to rise when the cost of living increases.
Since World War II, the five years in which U.S. inflation was at its
highest were 1946, 1974, 1975, 1979 and 1980 (as of 2012). During those
five years, the average real return on the Dow Jones Industrial Average was -12.33%, compared to 130.4% for gold.
4. DeflationDeflation, a period in which prices decrease, business activity slows and the economy is burdened by excessive debt, has not been seen globally since the Great Depression of the 1930s. During that time, the relative purchasing power of gold soared while other prices dropped sharply.
4. DeflationDeflation, a period in which prices decrease, business activity slows and the economy is burdened by excessive debt, has not been seen globally since the Great Depression of the 1930s. During that time, the relative purchasing power of gold soared while other prices dropped sharply.
5. Supply ConstraintsMuch of the supply of gold in the market since the 1990s has come from sales of gold bullion from the vaults of global central banks.
This selling by global central banks slowed greatly in 2008. At the
same time, production of new gold from mines had been declining since
2000. According to BullionVault.com, annual gold-mining output fell from
2,573 metric tons in 2000 to 2,444 metric tons in 2007 (however,
according to Goldsheetlinks.com, gold saw a rebound in production with
output hitting nearly 2,700 metric tons in 2011.) It can take from five
to 10 years to bring a new mine into production. As a general rule,
reduction in the supply of gold increases gold prices.
6. Geopolitical UncertaintyGold retains its value not
only in times of financial uncertainty, but in times of geopolitical
uncertainty. It is often called the "crisis commodity," because people
flee to its relative safety when world tensions rise; during such times,
it often outperforms other investments. For example, gold prices
experienced some major price movements this year in response to the
crisis occurring in the European Union. Its price often rises the most
when confidence in governments is low.
7. Portfolio DiversificationThe key to diversification is finding investments that are not closely correlated to one another; gold has historically had a negative correlation to stocks and other financial instruments. Recent history bears this out:
- The 1970s was great for gold, but terrible for stocks.
- The 1980s and 1990s were wonderful for stocks, but horrible for gold.
- 2008 saw stocks drop substantially as consumers migrated to gold.
8. Increasing DemandIn previous years, increased wealth of emerging market economies
boosted demand for gold. In many of these countries, gold is
intertwined into the culture. India is one of the largest gold-consuming
nations in the world; it has many uses there, including jewelry. As
such, the Indian wedding season in October is traditionally the time of
the year that sees the highest global demand for gold (though it has
taken a tumble in 2012.) In China, where gold bars are a traditional
form of saving, the demand for gold has been steadfast.
Demand for gold has also grown among investors. Many are beginning
to see commodities, particularly gold, as an investment class into which
funds should be allocated.
In fact, SPDR Gold Trust, became one of the largest ETFs in the U.S.,
as well as one of the world's largest holders of gold bullion in 2008,
only four years after its inception.
The Bottom LineGold should be an important part of a
diversified investment portfolio because its price increases in
response to events that cause the value of paper investments, such as
stocks and bonds, to decline. Although the price of gold can be volatile
in the short term, it has always maintained its value over the long
term. Through the years, it has served as a hedge against inflation and
the erosion of major currencies, and thus is an investment well worth
considering.
