Since 3000 BC, gold has been used as a medium of exchange and during the 18th Century it became the world monetary standard.
Few metals have drawn such attention and stood the test of time and, even today, it has an important role to play in global finance.
It is an asset class which investors regard as the ultimate safe haven. When currencies or markets are going through torrid times, investors “de-risk” their positions and head for the safety of assets such as government bonds and, of course, gold itself.
Gold is among a rare bunch of financial assets which does not reflect any kind of liability – and its supply is finite. Unlike currencies, equities or bonds, it cannot become worthless through the default of the issuer of that class. As such, it has proved a remarkably resilient store of value over hundreds of years, and in addition is an asset where investors seek protection when they need it most. Just one example of this was a flight to gold in 1999 as fears rose around the technological disaster (which of course never happened) that was dubbed as the Millennium, or Y2K, Bug.
There is also a slightly unusual point to consider as we approach the Christmas season. Much of the demand for gold is seasonal, from the Indian wedding season which begins in August, to the festive period in the Western world. It is estimated that 75% of physical demand for gold comes from the jewellery market and, according to the World Gold Council, this resulted in sales of $40 billion in 2005.
Traditionally, a weak US Dollar and rising oil prices are good for gold. Certainly the USD has been a source of weakness of late, as interest rates look to have subsided and with the result that a wall of money could be switched out of the dollar into higher yielding economies. Gold prices generally move in the opposite direction to the dollar, one reason for which is that by being quoted in dollars, gold immediately becomes more valuable if the dollar falls. In other words, if the dollar price falls, it takes more dollars to buy gold and so the gold price will rise. This is a tried and tested theory over history and is a classic inverse relationship.
With oil, the relationship is rather similar. If, for example, the oil price is weak (again not necessarily where we are today) gold loses its appeal as an inflation hedge. This is because higher oil prices will usually (amongst other reasons of course) lead to higher inflation and can therefore spark a movement of investors into gold as a hedge against this higher inflation. Higher oil prices tend to slow down the economy both in terms of higher manufacturing costs, as well as less individual disposable income as energy costs rise. Indeed, gold futures reached a record $870 an ounce in January 1980 at a time when oil prices had doubled in a year, therefore triggering a hike in the inflation rate.
There are some good reasons, therefore, why many market commentators are suggesting this could be a good time for gold. The oil price has been strong over the last year, notwithstanding the more recent fall, and the currency experts seem to agree that the US dollar could be weak for some time – both classically good pointers for gold, as described above.
Also, for the investor who is not convinced about market stability, a situation of both reducing risk and achieving investment diversity can be achieved by a movement of some of the portfolio into gold – be that through Krugerrands, gold bars, derivatives, mining shares, mutual or investment funds or even Gold Certificates.
In summary, gold as a store of wealth has a proven track record which at least matches any other investment class, and is a refuge for those times in the investment cycle when difficulties arise, be they market related or due to political tensions or war.
Whilst other class of assets have historically outperformed due to their relatively higher risk profile, the generally accepted investment wisdom of diversification is one which still rings true.
Richard J Hunter
Head of UK Equities
Hargreaves Lansdown Stockbrokers