Sunday, October 21, 2012

Why Gold? Inflation and the Dollar.

During economic uncertainty it has become essentially economics canon to purchase and stockpile gold as an investment or hedge. Why is this the case? Clearly, gold has little or no practical uses. Of course, it used as jewellery, and has a number of uses in the field of electronics manufacturing, but not nearly enough to support present-day production and supply. 

Prior to Nixon removing America from the gold standard in 1971, the U.S. dollar was pegged at $35 per ounce of gold. After 1971, the U.S. dollar essentially became a free-floating currency backed by nothing but our imagination. To help hedge against this uncertainty, it became increasingly important for a lot of investors and wealthy individuals to store a certain amount of their savings or reserves in the form of gold to prevent being stung by a collapse in the U.S. dollar. 

Currently at $1721, gold has continued its stratospheric move upward, primarily due to perceived instability and over-supply of the U.S. dollar. So why do people buy gold? They expect inflation, or a general decline in the purchasing power of their currency. One ounce of gold, for instance, could buy a fine suit in 1971 and in 2012, but in dollar terms, the same suit would have increased in cost from less than $100 to $1700... If someone had held their reserves or savings in cash during this period, their buying power would have essentially completely collapsed. If, therefore, you have a reasonable amount of savings, you do not want to hold it in cash or low-interest savings accounts for any extended period of time! It is almost guaranteed to lose its value.

Some other more generalized reasons for why people choose to invest in gold are as follows:

  • It is durable - it doesn't corrode.
  • It is divisible and homogeneous - you can break it up into smaller amounts.
  • It is easily recognisable and hard to counterfeit.
  • It has a stable supply because it is hard to get out of the ground.
  • It is portable.
  • It has a strong history accepted as a medium to facilitate exchanges. 
Keep in mind, however, that gold does experience wild swings in popularity amongst both central governments and investors, and thus can leave even astute and Intelligent Investors in substantial negative territory for some time in dollar terms. So buying gold is not a sure-fire way to curb against inflation, but included in a basket of resources it is a nice start.

Cheers and happy investing!


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