Why Buy Gold?

Gold has been one of the best investments over the last decade going from a low of $252 to a high of $1889. If you’re looking for a way to protect against the effects of inflation, currency collapse or economic instability, here are a few things to consider about why gold should be in your portfolio.

Return to the Gold Standard

If you’ve been paying attention to what is going on in the world these days, you know that the financial markets have been in turmoil. Much of this relates to the basic underpinnings of the economic system. In the United States, the Federal Reserve is in charge of the money supply and interest rates. Nothing is backing the paper money that is printed, other than the credit of the United States government. So just like when a company issues more shares of stock diluting the ownership of the existing owners, every time the Federal Reserve increases the money supply, it lowers the purchasing power of the dollar.

Since July 1944, when delegates from all 44 Allied nations gathered in Bretton Woods, New Hampshire., the dollar has been the reserve currency of the world. This gave it an advantage, because other countries needed it in order to engage in trade with one another. Prior to this countries traded gold with each other to settle their debts. After Bretton Woods they could exchange Dollars instead and the U.S. Dollar was supposed to be pegged at $35 per ounce of gold. But the U.S. began inflating the dollar and before long all that was left was an illusion that it was worth $35 an ounce. So wisely other countries began calling the United States bluff and requesting gold for $35 an ounce and eventually Nixon was forced to admit that we couldn’t afford to sell it at that price any longer and he was accused of “closing the Gold Window”

But Nixon still had one trick up his sleeve, in the early seventies the US still was basically oil independent, i.e. it produced enough oil for its own consumption. In an effort to protect U.S. oil companies against foreign competition, it created imports restrictions. So, in exchange for the lift of import restrictions, the OPEC countries promised they would only accept dollars for their oil. This gave the dollar back the control it lost when it gave up gold convertibility. Since the dollar was needed to buy oil from the Middle Eastern countries (and everyone needs to buy oil everyone needed dollars as well). In the last year or so, many countries like the BRIC nations (Brazil, Russia, India, China) have started to get away from the dollar as the world reserve currency. Instead, they are trading in gold. What effect will this have on the dollar and the United States? See Why (and How) China is Boosting the Price of Gold for more information.

Many experts believe that this will inevitably force the dollar and the monetary system as a whole back onto a defacto gold standard whether it is an official gold standard or not. When countries reject the idea of the dollar as the reserve currency, they will need something to replace it. Gold is a natural fallback because of its consistency and inherent value. When the monetary system returns to a gold standard, the value of gold will go up (or the value of dollars will go down). Anyone who has gold, will make a nice return on their investment.

Buy Gold as a Hedge Against Inflation

Gold also works as a natural hedge against inflation. It is a substance that has had some kind of value in every society the world has ever seen. Being a physical asset, it always has some value relative to the currency. While paper money has come and gone,  2000 years ago, under the Roman Empire, an ounce of gold purchased an upper class Roman citizen his toga (suit), a leather belt, and a pair of sandals. Today, one ounce of gold will still buy a man a suit, a leather belt, and a pair of shoes. Although in the short term its value varies. See Gold is a Crisis Hedge.

 

From this chart we can see that inflation has occurred on a massive scale and will only get worse under the current system. As inflation increases, the value of the gold in your portfolio will continue to go up as well.

Some experts believe that someday we will buy gold for $10,000 an ounce. With all of the debts that the central banks and governments have racked up, at the current price, there isn’t enough gold in the world to pay them all off. So the price per ounce must jump up significantly. If  the world rejects paper and wants “real assets” to settle their debts, anyone who has gold is going to do quite well.

Buying and Selling with Gold- No Paper Necessary

Another reason that you may want to invest in gold is because you can actually barter or trade with it. If you have gold coins, these could be used as a way to trade if the monetary system collapsed or if some other serious economic event occurred. While no one likes to think about this scenario, it is possible. Every country that has ever used paper money has inevitably crashed, and there’s no precedent to make us believe that it won’t happen in today’s society as well. Just because we figured out how to make iPhones and fly to the moon, that doesn’t mean that our society is beyond a form of collapse at some point. Anyone who owns gold is going to have a much better chance of being able to thrive in that environment.

When to Buy Gold

Gold typically thrives when interest rates are low because the “opportunity cost” of holding it is low. The opportunity cost is what you have to give up in terms of another  investment in order to hold something. In other words what else could you do with your money ? If the interest rates are high, you are giving up all that interest income. But if interest rates are low you aren’t giving up much to hold a much safer investment, so gold demand goes up. Head of the Federal Reserve, Ben Bernanke has vowed to keep interest rates low for years to come, so Gold has little competition from interest producing assets.

By comparing gold to oil you can see when gold is cheap.

Buying Gold

If you want to buy gold, there are a few different ways that you could go about it. One of the easiest ways to invest in gold is to buy shares of gold exchange-traded funds (ETFs) or Mutual Funds. This can be done through your current brokerage account. Another option is to buy gold stocks, i.e. of gold mining companies. Their profits are directly tied to the value of gold. You can also buy physical gold locally, from gold or coin dealers or even on eBay. The advent of independant grading servicies like PCGS, NGC and ANACS have made it easy to be sure you are getting genuine gold coins. Regardless of how you do it, many advisors recommend holding at least 5% of your portfolio in Gold as a hedge against catastrophe and amounts above that as a hedge against inflation.

See Also:

• Why China is Buying Gold (and encouraging its citizens to do so as well).
• Gold is a “Crisis Hedge”
• Its Weight in Gold: The Real Prices of Things
• Gold… the Timeless Inflation Hedge – More gold price comparisons like 400 BC: During the reign of King Nebuchadnezzar, an ounce of gold bought 350 loaves of bread.  Today, an ounce of gold still buys 350 loaves (or more).
• How to protect yourself against the ravages of Inflation?
• Gold the Timeless Inflation Hedge
• Gold is still Money
• How do Gold Stocks Perform in a Depression?
• How High will Gold Get?
• At $1000 is Gold Expensive?
• Can you Put Gold in Your IRA?
• Forecasting Gold and Silver Prices

About the Author:

Chris Keenan, a blogger for a new jersey home insurance company, writes on a variety of topics from payroll financing to family financing management.