Historically gold has been used as a relative standard for currency since ancient times. Gold has been used by the ancient Egyptians for millennia but discovery in the western world was more recent: 1848 in California and 1851 in Australia. So investing in gold has been commonplace for well over 150 years now.
At the end of the Second World War the US Dollar was pegged to gold at a fixed rate per troy ounce. This became the global system, which continued until 1971 when the US unilaterally suspended the direct convertibility of dollars to gold and adopted a fiat currency system (a fiat currency is one whose value is set by government regulation). Again this became the global system and the last currency to be separated from gold was the Swiss Franc in 2000.
The price of gold is most commonly set by the London Gold Fixing, a regular meeting of the major bullion trading firms on the London Bullion Market. The global trade in gold is based on the spot price and this is continuously updated see goldprice.org
Gold prices have made several headlines over the past few years as the market has fluctuated wildly and previous record prices have been broken. In March 2008, the gold price broke the $1,000 barrier, achieving a record high of US$1,004.38. After this spike, gold prices declined again to a low of $712.30 per ounce. Pricing soon spiked again however, and the $1,000 barrier was passed again in February 2009, only to briefly regress in the months following. By the end of 2009 the spot price record of US$1,033.90 had been broken several times and the price of gold began to climb to unprecedented levels. In August 2011 gold reached a new record high of $1,889.70
The total of gold mined is a measurable, finite amount (approx 158,000 tonnes) and this still all exists, the vast majority of it as bullion or coins in vaults around the globe.
So what causes the fluctuations in the spot price for gold? Gold operates according to supply and demand the same as any other commodity, but with one major difference: it is not a consumable.
The fact that this could all potentially enter the market means that demand has a much greater role to play than supply. The recent peaks in the gold market are almost definitely a symptom of the financial unrest and turmoil that has characterised the past few years.
With uncertainty and a palpable lack of confidence in the financial system as a whole, and in particular the banking sector, investors have become nervous. Investments that had always been touted as “can’t lose”, such as the UK property market, crumbled. Some of the more inventive, highly complex financial products were found to be disreputable. Even the pension plan that had been guaranteed for all your working life turned out to be near worthless. In light of this situation and with no faith in the system investors did what they have always done in times of crisis; turned to good old-fashioned, immutable gold. Those who did so at the beginning of the crisis are laughing about it now.
Is it too late to invest in gold?
The trouble with markets that rise as dramatically as the recent gold market is that it’s difficult to know when you are at the top. The UK property market serves as a useful analogy again. Whilst for many years some investors were making money hand over fist, those who bought at the top of the market fared much worse. They believed in continual growth, but nothing can grow forever and these people are now shackled by their properties, or worse, have lost them through repossession.
So is it still a good time to invest in gold?
Well, much of gold’s rally in 2011 (approximately 25%) has been a result of worries over the US and Euro zone debt burdens, and more specifically the impact this is having on currency markets. Investors, like a large slice of the population, have lost faith in governments and their central banks. With the US contemplating another round of quantitative easing and European governments appearing to be helpless, investors are still finding solace in the apparent safety of gold.
Gold investments received another boost when the central bank of Switzerland recently announced that it would set a limit on how much the Swiss Franc could gain. The strength and stability of the Swiss Franc have meant that it has been considered a safe haven alongside gold. With the Swiss pegging their currency to the Euro, investors in Swiss Francs have been moving their money into gold.
Gold is likely to rally again in the immediate future.
Looking a bit further ahead, expert opinion is split quite equally into two opposing camps (you didn’t expect a straightforward answer did you?). Some believe that the unprecedented leap in gold prices is an anomaly and that gold is about to undergo a deep correction, crashing prices. Others believe that as long as the financial turmoil continues (and it seems set to for at least the short term) then gold prices will continue to rise and gold’s status as a safe haven will be assured into the future.
What kind of gold should I buy?
The answer to this question really depends on why you are buying it. If you are simply attracted by the ebullient market and want to profit from upwards price movements then gold bullion will serve the purpose. Bullion carries the lowest premium above melt value and is the form of gold with most liquidity enabling an easy sale when you want to sell it. If you are more interested in a long term strategy, or have concerns about monetary controls then you may wish to consider older gold coins (pre – 1930s). These are often considered historical items rather than currency and afford the investor greater privacy. They can be acquired at reasonable premiums and will hold their value into the future. Be sure to check out your national regulations regarding this. A consultation with a gold broker would be a good place to start.
The most common type of bullion for small time investors to buy is bullion coins, these coins have a minimal premium above melt value and are easily traded. In the UK gold sovereigns are particularly interesting;, not only are they familiar to UK residents, they are exempt from UK capital gains tax.
Investing in gold means that your gold needs to be safely and securely stored somewhere. If your gold is insured then, depending on the value, your insurance company will probably insist that it is stored in an approved facility. One of the more popular ways of investing in gold is to buy gold bullion which is stored for you in a secure vault. In this scenario there is no need for you to actually even see the gold (although you can withdraw it if you pay a premium, it is yours after all). All transactions are carried out on line and you just need to concentrate on the numbers. Find out more about this on our page on How to Buy Gold.
Another way of investing in gold, without actually buying any, is to invest in a gold fund. Funds linked directly to mining do not echo the prices realised by actual gold. As explained above, the current boom in the gold market has nothing to do with supply and everything to do with demand. An Exchange Trade Commodity (ETC) is maybe a better investment. ETCs operate like a tracker fund that tracks the price of gold as it rises and falls on the open market. Take a look at our pages on How to Invest in Gold for more information.