Investment in gold deserves a mention in this blog, because gold is an important asset class from the perspective of a wealth insurance, but usually this is not known and not considered by people generally.Disclaimer: This article merely expresses the authors views and are not recommendations for action by the reader. YMMV.
Concept of money as a medium of exchange
Before we talk about gold investment, allow me to talk a little on background of money. Some explain money as "Money is what money does", which means that money is a medium of exchange. In the good old days, money notes is designated to be a promissory note of guarantee and as a means of convenience to replace physical gold as the currency. It was a medium of exchange that allows one to trade between different items using a common denominator of value, and over time, the entire world economy grew to depend on money as its lifeblood.
The Bretton Woods system
As the world progressed into modern times and global trade and commerce started to bloom, it was recognised that there's a need to establish a common policy for international monetary management. The Bretton Woods system was established in 1944 as a set of rules of commercial and financial relations among the major industrial nations. It was also in the same time period that an international regulatory financial body like International Monetary Fund (IMF) was established. The primary feature of the Bretton Woods system is that the nations are obliged to peg their currency at a certain fixed rate to gold with a 1% spread between the buy and sell rates. It was a good and stable system that is in a way backed by physical gold. For the world's dominant leader, the US dollar was pegged at USD35 per ounce of gold.
However, by early 1970s, US's participation in the Vietnam war accelerated inflation, and for the first time in modern history, the nation as a whole began running a trade deficit. The reasons for an accelerated inflation can be attributed to a massive consumption of resources and the government began to finance this consumption by printing more money notes. As this war went on, people started to swap their dollars for physical gold. Because of excess printing of money by the US government, nations began demanding US to fulfil its promise to pay, by a conversion of dollars into gold. This came to a tipping point where US's gold coverage deteriorates from 55% to 22% and it represented the point where holders of the dollar lost faith in US's ability to cut it's budget and trade deficits.
Collapse of the Bretton Woods system and emergence of the floating currency
In 1971, the United States devalued its currency from USD35 per ounce of gold, to USD38 per ounce of gold. In 1972, it reached USD70 per ounce. In 1973, the Bretton Woods currency markets closed and subsequently reopened as a floating currency regime where the dollar is no longer pegged at a fixed rate to gold. Today, the exchange rate stands at startling rate of USD823 per ounce of gold and this is expected to rise further.
Fiat money and the risks of hyperinflation
As United States grew to became the modern day economic powerhouse, the dollar became the de facto currency that many countries view as gold. The dollars became a favourite denomination for countries to keep in their vaults as foreign currency deposits.
And as the circumstances in the world evolved, it somehow becomes apparent to me that our world's economy now hinges on fiat money - money is designated as a medium of exchange because the government said so. It runs purely on the confidence in the government, and holds no intrinsic value. For the world's economy to fall apart, all it takes is for a critical mass of people to lose faith in their government's currency and began collectively raising prices mindlessly. Humans have the herd instinct, once the confidence is shaken, things can spiral out beyond control like what happened in Zimbabwe, where money completely loses its effectiveness as a medium of exchange. (read here)
Gold: insurance of wealth against runaway inflation
Gold is an asset class that will not lose its effectiveness as a medium of exchange because of the underlying intrinsic value and limited global supply. It is an excellent form of liquid asset class that can help insure us against a currency fallout. The risk of a currency fallout is remote, but it is there and as a rational human being, I will want to guard against such a catastrophic situation. Let me draw an analogy: we buy life insurance even though the risks of death and critical illness are statistically remote - for the simple reason that we want to preserve our state of wealth and minimise impact on our loved ones if something unfortunate strikes. Likewise, buying some gold can help to preserve our hard earned wealth and standard of living should an unfortunate case of currency fallout strikes. Although very unlikely, I do not completely rule out that possibility. And if ever a currency fallout does happen, I want to know that I can still use ounces of physical gold to sustain my daily needs.
Buying how much gold is enough then?
Historically, when hyperinflation occurs and prices rise beyond 1000%, gold prices will also rise more than 1000%. A good rule of thumb to start with is that we should probably strive to build 10% of our net worth in gold. So in the event of hyperinflation, gold price can be expected to rise such that we can still retain 100% of our current net worth.
Methods on investing in gold
We can invest in gold in basically 3 different forms. Either physical bullion, paper gold certificates, or Exchange Traded Funds. If you think of buying gold, it can be acquired in the form of physical bullion from official websites like http://www.kitco.com/. The online market also allows one to sell off gold. Just a comment on physical bullion: the bigger the gold bar, the cheaper it is in terms of per ounce, but also less liquid. Gold is much more liquid in forms of widely recognised coins like the Canadian Mapleleaf coin (see picture above)
A fellow forumer, who is incidentally my brother, has written excellent articles on gold investing. (Read How to Invest in Gold, History and going forward, Investing in Gold)
For further information and open forums on investments in gold, you can go to http://www.goldclubasia.com/
Other interesting points about gold:
Market movements have shown that crude oil prices and gold are in many ways correlated. It has been widely recognised that oil and gold have one of the strongest historical commodities relationship. It is even more interesting to note that back in 1975, oil was pegged at USD75 per barrel, as compared today's prices of USD113 per barrel. Now, compare that against the gold exchange rates: in 1975, USD40 per ounce of gold. Today, it is USD823 per ounce of gold.
I shall leave you at this thought. For further reading, see here.
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