Whenever the subject of gold as an investment is discussed in our circles, it immediately becomes apparent that we are dealing with a highly emotional issue. There appear to be two schools of thought: gold fanatics and gold haters. However, many of the arguments put forward by either side are based on misunderstandings and dyed-in-the-wool myths that we would like to enumerate and analyse in the course of this article.
From an economic point of view, what is the significance of investing in gold as opposed to other forms of investment? Investments in gold are obviously not the same as holdings in so-called productive capital such as shares. Unlike investments in shareholdings, gold does not generate added value through innovation, research or development. Successful firms create added value via their participation in profitable entrepreneurial activity that in turn rewards investors in the form of dividends. However, shareholders take on a business risk and, if the worst comes to the worst, they stand to lose the entirety of their capital.
Investments in the form of fixed-yield securities and bonds have the reputation of being relatively safe investments that nevertheless pay dividends. Even here, investors face elements of insecurity such as the not inconsiderable risk of fluctuations in interest rates during the lifetime of an asset-backed security. The risk of default in the bond market is often disregarded. As a general rule, the higher the risk of default, the higher the rate of return. Consequently, the level of return on an investment can be thought of as a risk premium in the event of its default. From a legal point of view, the investor has a claim against the debtor. Although today it is highly unlikely that a country’s creditors could stand to lose the capital that they have invested, or part of it, there are countless historical examples that demonstrate this possibility.
Holding gold, on the other hand, is ownership in its purest form. In contrast to fixed-interest bonds, there are no claims on third parties. Gold represents zero entrepreneurial risk and can never become worthless. This is also the economic explanation as to why no interest is payable on gold. This very fact is gold’s badge of quality. Conversely, with bonds it can be argued that the worse an issuer’s credit rating, the higher the interest that will (have to) be paid. Gold can therefore be seen as an issuer of the highest creditworthiness and reliability; one that can never go bankrupt. As owners and holders of gold, we can be assured that existing reserves of gold cannot be expanded in the short term due to inflationary effects (see Gold as an asset). Historically, the total amount of gold in circulation tends to increase in line with economic activity. This is another reason why gold has remained a stable investment whose purchasing power has not declined over generations. Today the price of an ounce of gold roughly corresponds to the cost of having a suit tailor made. In ancient Rome, the value of an ounce of gold was the equivalent of a toga. This is a highly illustrative example of the metal’s extremely long-term value stability.
In the short and mid-term, substantial variations in the value of gold are to be expected and must be borne in mind when making an investment. It is often said that gold is a highly speculative and volatile investment. If we compare the fluctuation range (the so-called volatility) of gold with that of other types of investments, it becomes clear that gold is anything but extremely volatile. Over last ten years, the volatility of the Dow Jones Index has been around 16% while that of gold has been 12%. This figure is confirmed in a study carried out by the World Gold Council. Similarly, the fluctuation range of gold prices over the last 20 years has been substantially lower than that of crude oil, other precious metals, the GSCI commodity index or the majority of share prices. Nevertheless, these fluctuations should be taken into account and not underestimated, especially in the case of short-term investments.
Gold is a serious, long-term investment, not only suitable for times of hyperinflation and banking crises. Its historic significance, along with its limited supply, makes the purchase of gold a much-loved hedging strategy in the face of increasing inflation, particularly when interest rates do not compensate for a currency’s loss of purchasing power. Naturally, the fundamental rule of investment – don’t put all your eggs in one basket – should be observed. However, within the framework of a balanced portfolio, gold can serve as an excellent insurance policy with interesting diversification effects. In the history of man there have been very few investments that have maintained their value over thousands of years. The total abandonment of gold as an investment amounts to an ignorance of history.