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Why Invest

Why Should You Own Gold and Silver?

Gold is a monetary metal whose price is determined by inflation, by fluctuations in the dollar and U.S. stocks, by currency-related crises, interest rate volatility and international tensions, and by increases or decreases in the prices of other commodities. The price of gold reacts to supply and demand changes and can be influenced by consumer spending and overall levels of affluence.

Gold's value arises from its use and worldwide acceptance as a store of value. Gold is money. In the coming decade, as the dollar suffers one of the great meltdowns in monetary history, gold will reclaim its place at the centre of the global financial system. Gold's value, relative to most national currencies, will soar.

Historically, gold has been attributed with these factors but in the modern time, Silver has actually become the 'new gold'. Hence, these aspects apply to 'Bullion' in general.

There are five primary reasons why investors own bullion:

  1. Bullion as a hedge against inflation and against a declining dollar.
  2. Bullion as a safe haven in times of geopolitical and financial market crises.
  3. Bullion as a commodity based on supply and demand fundamentals.
  4. Bullion as a store of value.
  5. Bullion as a portfolio diversifier.

Take a look at the following summary of the six primary reasons for investors to own gold. They may never be more relevant than they are today.

I. HEDGE AGAINST INFLATION AND AGAINST A DECLINING DOLLAR

Gold/Silver is renowned as a hedge against inflation. The most consistent factor determining the price of these two metals has been inflation - as inflation goes up, the price of precious metals goes up along with it.

In the US, during years when inflation was at its highest (1946, 1974, 1979, 1980), the average real return on stocks, as measured by the Dow, was -12.33%; the average real return on gold was 130.4%. Bullion, in general is a hedge against inflation.

Crude oil prices are one of the crucial determinants of inflation. Although the prices of gold and oil don't exactly mirror one another, oil prices do affect gold prices. If oil prices rise or fall sharply, investors can expect a corresponding reaction in gold prices.

Currently, a number of factors are conspiring to create inflationary pressure. These include a long term decline in the dollar, a spike in oil prices, a mammoth trade deficit, and of course USA's status as the world's biggest debtor nation.

Bullion is generally bought and sold in U.S. dollars, so any decline in the value of the dollar causes the price of bullion, especially gold to rise. The U.S. dollar is the world's most traded currency. It is the currency primarily held as reserves by the world's central banks. It is the primary medium for international transactions and also the principal store of value for savings. However, now that it has been stripped of its gold backing, the dollar has lost its sheen completely.

II. BULLION AS A SAFE HAVEN

Gold & Silver have often been called the "safe haven" because they normally outperform other investments during periods of world tensions. The same factors that cause other investments to suffer cause the price of gold and silver to rise.

As seen during 2007-08, subprime crises almost sunk the US economy. Similarly, a bad economy can sink poorly run banks. Integration of the global economy has made it possible for banking and economic failures to destabilize the world economy, as seen during the aftermath of the US crises. Indian stock markets too suffered a big blow due to the same and the Sensex crashed from its peak at 21078 on January 8th 2008, to a low of 8701 on October 24th 2008 – down almost 60% in less than ten months! During the same period, gold and silver prices rose tremendously. This is because banking crises occur; public begins to distrust paper assets and turns to gold and silver for a safe haven.

When all else fails, governments rescue themselves with the printing more notes, making their currency worth less and bullion worth more. Gold and Silver has always risen the most when confidence in government is at its lowest.

III. BULLION AS A COMMODITY - SUPPLY AND DEMAND

Bullion demand is much higher than supply across the world. Gold production is declining; Silver production is declining and the production of other metals is declining. Opening a new mine is not an easy task when the whole process takes about seven years on average, making it difficult to address the supply issue quickly. Output of precious metals in South Africa, one of the world's largest gold producers, fell to its lowest level since 1931. It's produced 32 million ounces of gold in 1970 which had gradually declined to just 6.6 million ounces in 2009.

Growing Demand - India and China

India is the largest gold-consuming nation in the world. China, on the other hand, has the fastest-growing economy in modern history. Both these economies have made it easier for their citizens to invest, consume and sell bullion. It is only in the last few years that we have seen innovative investment products based on gold and silver.

In India, the sheer importance of gold and silver is very high because of culture (marriage demands), traditions (festive demands) and religions (donations). In fact, India is often termed as the 'heart of gold'.

IV. BULLION AS A STORE OF VALUE

One major reason investors look to gold & silver as an asset class is because it will always maintain an intrinsic value. Gold will not get lost in an accounting scandal or a market collapse.

Economist Stephen Harmston of Bannock Consulting had this to say in a 1998 report for the World Gold Council,"…In a period of a long bull run in equities, with low inflation and relative stability in foreign exchange markets, it is tempting for investors to expect continual high rates of return on investments. It sometimes takes a period of falling stock prices and market turmoil to focus the mind on the fact that it may be important to invest part of one's portfolio in an asset that will, at least, hold its value."

Today is the scenario that the World Gold Council report was referring to in 1998.

V. BULLION AS A PORTFOLIO DIVERSIFIER

A portfolio can only be termed as a diversified one if it has assets that are negatively correlated with each other. Also, the most effective way to protect the wealth created in the stock and financial markets is to put it together with gold and silver. Bullion is the ideal diversifier for a stock portfolio, simply because it is among the most negatively correlated assets to stocks. Investments in bullion may also help in diversifying a portfolio which consists of real estate assets.

Because most stocks are relatively closely correlated and most bonds are relatively closely correlated with each other and with stocks, investors should combine tangible assets such as gold/silver with their stock and bond portfolios in order to reduce risk. Bullions and other tangible assets have historically had a very low correlation to stocks and bonds. Diversification of investments can improve overall portfolio performance as recommended by major investment gurus.

Although the price of gold can be volatile in the short-term, gold has maintained its value over the long-term, serving as a hedge against the erosion of the purchasing power of paper money. Gold is an important part of a diversified investment portfolio because its price increases in response to events that erode the value of traditional paper investments like stocks and bonds.


 

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