WHY HAS GOLD BEEN HITTING RECORD HIGHS?
Roy Davidson, 9 October 2020
It is a soft, shiny metal used in relatively few industrial applications. It also doesn’t provide its holder with any income to speak of. So why do we hold gold in such reverence, hoarding it and storing it away in vaults? And why did the price of gold recently hit all-time highs?
Gold – the OG money
Gold isn’t quite the first money used by humans. Seashells, barley and even salt (from which the word salary is derived) served as money before gold and its cousin silver.
In the end though, it was gold that satisfied the basic criteria of a successful currency more than any other. It is durable, can be divided into smaller amounts, is the same everywhere, and it is portable. It is also relatively rare with new supply limited by our ability to mine it. This means it holds its value pretty well over time. These qualities gave rise to our love for the yellow metal and saw gold conquer the monetary world.
Most large global economies operated under a gold standard monetary system, under various designs, until pretty recently. Holders of major currencies, like the US dollar and British pound, were able to instantly convert their currency into a set amount of gold at any time.
However, the Great Depression severely weakened the gold standard and ultimately, in 1971, facing increasing redemptions of US dollars for gold from other countries, the US Government finally abandoned the convertibility of the US dollar to gold. This ended the last stand of gold as the backbone of the monetary system and gave rise to today’s current fiat monetary system where the value of a currency is derived from governments decreeing it to be the unit of exchange.
Record highs driven by safe haven status
Despite no longer being an official currency, gold itself hasn’t changed. It still has all the qualities that drew people to use it as a currency in the first place. Its role as a store of value typically sees people flock to it during periods of uncertainty when the prices of other assets, like shares, are falling.
Importantly, its supply is relatively fixed, with the amount of gold in use increasing by a marginal amount each year. This has been the key driver behind the price of gold hitting record highs since the emergence of COVID-19. With central banks around the world opening the monetary floodgates in a bid to support economies, gold has found favour with investors fearing higher levels of inflation down the track.
Unlike money at the bank, gold doesn’t provide its holder with any income. As a result, anyone owning gold must always be aware of the interest they are forgoing by not parking their money at the bank (or in shares or property) instead. Accordingly, as interest rates have fallen to record lows, the interest foregone by holding gold is much less than it once was, further increasing the appeal of gold.
The jump in US money supply growth has helped gold reach record highs
A way to manage risk
It is best to think of gold not as an investment, but more as a portfolio risk management and diversification tool.
Over the long-term, gold has been a vast underperformer relative to shares. For instance, over the past 30 years the price of gold has risen by 365 per cent. Not bad. However, over this same time frame, the US S&P 500 has delivered a total return of 1,924 per cent.
However, owning a small amount of gold in a portfolio can insulate portfolios from the impact of periods of market turmoil. However, over the long-term, gold is likely to underperform most other productive assets like shares.
How do you buy gold?
Gold isn’t cheap. A 1kg bar of the stuff will set you back almost NZ$100,000 at the moment, with a 1oz (31 gram) coin coming in at more than NZ$3,000.
An easier way is to simply purchase shares in a gold exchange traded fund (ETF). ETFs are funds that are traded on the stock market just like shares and usually track in index – in this case the gold price. Most gold ETFs are physically backed by gold bullion.