A dependable store of value
There’s no denying that gold is physically alluring, but so are many other assets. The reason gold has acted as a store of value for so long is its physical stability. Unlike most other metals it doesn’t corrode and unlike other precious items, like works of art, it’s essentially indestructible.
Today, gold’s stability translates into the investment arena: its price often holds up even when those of other assets, such as equities, bonds and real estate, are plunging. For this reason, it forms a significant part of many investors’ balanced portfolios. And it’s not just investors that appreciate gold’s ability to act as a safe haven. Central banks around the world are major buyers of gold, which they use to store value and diversify their reserves, reducing their exposure to volatility in the paper currencies they hold.
Protecting against inflation
One of gold’s most appealing characteristics is its ability to protect against inflation over the long term. Due to the effects of inflation, currencies lose their value over time. A good example of this is changes in house prices. Back in 1929, the average house price in the US was around USD $6,500. Fast-forward to 2024 and the average house price shot up to around USD $420,000, showing just how much a dollar has fallen in value over that period.
However, in 1929, 10kg of gold was worth around USD $7,300 – just enough to buy the average house. But by 2024, the same amount of gold was worth around USD $830,000 – nearly enough to buy two houses. Security risks aside, this suggests it’s a much better idea to stash away gold under your bed than cash.
What drives gold prices up?
Gold isn’t like other traditional investments – it generates no income and its supply is finite, so it’s subject to different return drivers. Often an inverse to inflation, volatility and geopolitical tensions, here are the four factors that drive up the price of gold:
1. When stock markets are volatile and geopolitical tensions are high
These kinds of developments make investors nervous, leading them to shun risky assets and move into the kind of safe-haven asset that gold has proven itself to be. Past episodes when gold has risen sharply include the covid pandemic (gaining around 30% between January and August 2020), Brexit (gaining 20% in the hours after the election results) and the US-China trade dispute of 2018–19 (causing gold to gain around 20%).
2. When interest rates are falling and vice versa
That’s because holding gold involves an opportunity cost – it provides no income itself, so when interest rates are high the opportunity cost is greater as it’s possible to receive higher income from other asset classes than when interest rates are low.
3. When the US dollar is falling in value
Part of the reason for this is that the price of gold is generally quoted in US dollars. So when the dollar weakens, it takes more dollars to buy the same amount of gold. But researchers have found that gold also tends to rise when other currencies are falling, suggesting that it acts like a currency itself.
4. When there’s strong demand from investors and central banks
Demand has a strong impact on gold prices. Demand for gold jewellery, which is especially seen in China and India can also impact prices, especially in certain seasons. Unlike for many other asset classes, gold supply can’t easily be ramped up to meet increased demand – it’s estimated that there is under 250,000 tonnes of gold in the whole world, and it takes a long time for gold miners to increase their output.
2024 provided a good example of some of these factors at work as gold rallied over the year. This was marked by intense geopolitical tensions in the Middle East and Ukraine, interest rates being cut and strong central bank buying.
How to invest in gold
Gold clearly represents an attractive prospect for many investors, but what’s the best way to access it? The most obvious is to buy physical gold, whether that be in the form of gold bars, coins or jewellery. The major problem with this approach is the security risk of owning physical gold and the cost of storage. Here are a few other ways to own gold without having to maintain gold in its physical form.
Exchange traded funds (ETFs)
An ETF or other investment fund that buys gold could be a good option for investors that want to incorporate gold in their portfolios. These funds involve fees, of course, and might require minimum investments, but it’s the approach that most investors choose. Each share represents a fixed amount of gold, such as one-tenth of an ounce, and you can buy and sell ETFs just like stocks. As a result, this is one of the easiest ways to invest in gold and is especially true for small investors, as the minimum investment is only the price of a single share of the ETF.
Mutual funds
Many mutual funds own gold bullion and gold companies as part of their normal portfolios, making it easy to incorporate gold in a balanced portfolio. However, only a few mutual funds focus solely on gold investing, as most own a number of other commodities as well. The advantage of including gold focused mutual funds in your portfolio are low cost and low minimum investment required, diversification among different companies, and no individual company research needed.
Gold futures and options
For more experienced or larger investors, futures and options offer the opportunity to invest in gold as well. Futures are contracts to buy or sell a given amount of an item on a particular date in the future. Investors often invest in futures because the commissions are very low, and the margin requirements are far below traditional equity investments. Gold futures contracts are standardized and represent a predetermined amount of gold. Some contracts settle in dollars, while others settle in gold.
Options on futures, on the other hand, are an alternative to buying a futures contract outright. Option owners can buy the futures contract within a certain time frame, at a preset price. One benefit of an option is that it both leverages your original investment and limits losses from the price paid. The downside of an option is that the investor must pay a premium above the underlying value of gold to own the option. Because of the volatile nature of futures and options, they may be unsuitable for many investors.
Mining companies
Another approach is to invest in the shares of gold mining companies. When the price of gold rises, these firms generally benefit as their profits increase. Unlike gold itself, they may also provide income in the form of dividend payments. The downside is that mining companies can also face risks such as labour strikes or political instability in mining countries.
As always when deciding how to invest, it comes down to your investment goals. Are you looking for long-term stability, short-term profit or portfolio diversification? It’s also important to remember your risk tolerance – gold is a safe-haven asset, but its price can still go down, resulting in more volatility than you’d like.