Is gold really the safe haven everyone says it is?

Posted: 18 June 2021 5:11 pm
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We explore why gold has earned its reputation as a long-term and desirable asset.

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Gold has been considered a store of value and a sign of wealth for thousands of years, but it has only been in the last few decades that it has gained importance as a financial asset.

Given its stability during periods of market volatility, investing in gold is considered a valuable hedge against inflation and a safe way to diversify a portfolio.

Gold prices jumped by a quarter during the coronavirus pandemic, hitting a record US$2,067 an ounce in August 2020. Since then, it has barely slipped below the US$1,800 mark as investors stick to the precious metal amid the ensuing global economic downturn.

But many analysts wonder if gold is now too high and question whether buying at current levels is even feasible. Here are some reasons many believe investing in gold can still be beneficial in the long run:

It preserves value

Gold is seen as a way to pass on and preserve wealth from one generation to the next. It is valued as a precious metal because of its unique properties – it doesn't corrode, cannot be melted easily, is durable, beautiful and easy to work with.

Unlike currencies, it cannot be printed in unlimited quantities. It is a scarce asset and is not directly impacted by governments, central banks or interest rate decisions. Gold is also known and easily accepted throughout the world, making it an excellent medium of exchange.

Safe haven asset

Gold is the safe haven of choice during periods of market uncertainty, and is generally seen as a store of wealth that provides greater security. For instance, gold prices shot up during market volatility from the COVID-19 pandemic because investors saw it as a safer bet than other assets. Gold retains its value in times of financial volatility or geopolitical uncertainty. This is why it is often referred to as the "crisis commodity".

Gold is also positively correlated with the price of other safe assets like treasury bonds, and negatively correlated with bond yields. The opportunity cost of investing in gold is also reduced in a low interest rate environment such as at present.



Hedge against inflation

Gold prices historically tend to rise when the cost of living increases, making it an excellent hedge against inflation. When a country's currency loses its purchasing power to inflation, gold, which is priced in the same currency, tends to rise along with everything else. Gold is also a real asset with limited supply, which also boosts its value.

In the context of investing, gold generally has an inverse relationship with the stock market and a depreciating US dollar. Since the 1970s, high inflation has resulted in stock markets declining and gold prices rising. Economic expansion too, especially in emerging markets such as India and China, is a positive for gold demand and price, as expanding middle classes there preserve wealth in the form of gold jewellery.

Limited supply

Gold is a finite resource, and will eventually be exhausted. Gold production fell 4% in 2020 to 3,401 tonnes, the second straight year of decline, according to the World Gold Council. While this was in part due to COVID-19 restrictions, analysts believe the growth in mine supply is set to decline in the coming years as existing reserves are exhausted and new major discoveries become rare. The reduction in the supply of gold will lead to an increase in gold prices.

On the demand side, around 60% of annual requirement comes from electrical, medical and the jewellery industries and remains stable. The remaining 40% is mainly driven by investors and speculators, and can be volatile. This balance between supply and demand keeps the value of gold stable.



Rising demand

Increased wealth in emerging economies is constantly boosting demand for gold. China is the world's largest gold consumer, where gold bars are a traditional form of saving. India is the second largest gold consumer, where the precious metal is mostly used for jewellery.

Demand for gold is also growing among investors, with an increasing number of gold trusts and exchange traded funds (ETFs), ramping up demand for gold bullion. The overall lift in demand is set to keep upward pressure on prices. And once inflation picks up due to the monetary stimulus introduced by central banks around the world, it could make gold even more attractive.

Useful for portfolio diversification

Diversifying a portfolio involves finding investments that are not closely correlated to each other so as to reduce overall risk and volatility. Historically, gold has had negative correlation to most other financial assets.

Gold typically performs well during bear markets and downturns, as well as when market volatility is high. Its price typically increases in response to events that cause the value of other investments such as stocks and bonds, to decline. Although the gold price can be volatile in the near term, it maintains its value over the long term. It should therefore form part of a diversified investment portfolio.

Despite the many apparent advantages of investing in gold, like any other financial asset, there are risks. Some of these are:

Timing affects value

Gold is volatile in the short term and its gains are determined by when and how long it is invested in. The best time to invest in almost any asset is when there is negative sentiment and the asset is inexpensive, but the recent economic uncertainty means it is trading at high levels. Similarly, gold investments yield a strong return only over the longer term.

No yield or dividends

Gold does not pay any sort of yield or dividend, unlike cash, stocks and bonds. Storing gold can, in fact, result in a negative yield. Gold is also an unproductive asset, in the sense that money invested in it does not contribute to any kind of economic growth, unlike with other financial assets.

This also means it's not possible to calculate the intrinsic value of gold, with the price entirely driven by demand and supply.

Liquidity and storage

If gold is purchased physically, it needs to be stored and transported. This can lead to an increase in the costs of holding it, compared to other investments like stocks or bonds. Even when gold is owned indirectly, you're exposed to the same liquidity risk faced by other financial assets. This means that you will not be able to convert it to cash at full value, in case of any disruption in the financial system.

If you are looking to gain exposure to gold, you can physically buy and store gold, you can invest in gold stocks or companies via the stock market, or trade gold CFDs on the financial markets. Here is how and where to buy gold in Australia.

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