Why Do People Invest in Gold?

Posted by Don on July 23, 2013

Gold has plummeted close to 30% in value. Gold was once valued at over $1,700 an ounce but now is sitting at around $1,200 an ounce (as of last week; see the current gold price for today’s gold rate). So what’s the deal with gold? Why do people invest in it and what’s up with the wild price swings recently? My goal is to provide you with a better understanding of gold so that you can be a better investor.

Gold

Photo Courtesy: Boykung

Why Do People Invest in Gold?

For the most part, investors invest in gold for two reasons:

Let’s look into each of these a little more. People buy gold to hedge against inflation. This means that people think that inflation is going to be rising. When inflation rises, you need to earn more return on your money to have the same spending power. Because banks take their time raising interest rates for deposit accounts and the volatility in stocks, people flock to gold. They see it as a safe bet against rising inflation.

The second reason is when banks are paying little to no interest on deposit accounts. Since this has been the case for the past five years, people have been flocking to gold as a possible alternative to low interest rates.

Both of these reasons have occurred since the housing collapse in 2008. Many people feared rapidly rising inflation rates and with interest rates being held down by the Federal Reserve, many investors had nowhere to turn but to gold.

However, there was a third factor at play here. Because of the seriousness of the housing collapse and countries in the European Union teetering on collapse, many feared the world’s financial markets were going to completely collapse. As a result, people invested in physical gold should paper money become obsolete.

All three of these factors helped increase the demand for gold, which drives up the price. But why the sudden drop?

Why Did Gold Drop in Price?

In June, Federal Reserve chairman Ben Bernanke said that the Federal Reserve is going to slowly stop printing money at its current rate, but he didn’t say when this would happen. (A little background here, the Federal Reserve has been printing money and injecting it into the bond market to the tune of $85 billion a month to keep interest rates artificially low. Doing this would hopefully drive people and business to borrow money at super low rates. The downside to this is the belief that it could lead to much higher inflation.)

When Mr. Bernanke said that the Federal Reserve would be slowly cutting back on the printing of money it signaled that the economy was slowly improving and that the fears of rapidly rising inflation were overblown. As a result, those that invested in gold to hedge against inflation had no further need to worry and they sold out.

Why Have Gold?

Back in the day, if you had gold, you were a king or queen. Since gold has a limited supply and is difficult to obtain, those without gold usually remained without gold. But the prospect of obtaining gold and becoming filthy rich is still ingrained in us to this day. I personally question why this is. If the world financial markets were to collapse tomorrow and paper money was worthless, why would I want gold? I would rather have food and water. I would not be interested in trading someone my cow for gold. I would want something meaningful to me in return – food, water, supplies for shelter, etc.

Final Thoughts

Gold is used as hedge against inflation. Why did gold spike and then plummet? It spiked because investors feared the worst – that the global economies were going to collapse from all of the governments printing excess supplies of money. As more and more investors bought into this fear, the price of gold continued to rise. (Up until the bubble started the majority of gold was bought and used in jewelry but by 2009, almost half of all gold was bought by investors. More proof of a bubble: all of the cash for gold advertisements you see everywhere. Remember, you know it’s a bubble when EVERYONE is getting in on it.)  Recently we have seen that their fears were unfounded. As a result many have fled gold, leading it to drop in price dramatically. It’s the classic story of a bubble. Does gold have a place in your portfolio? A small percentage may, but you shouldn’t be selling out of everything and going 100% gold. That plan is simply fool’s gold.

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Comments to Why Do People Invest in Gold?

  1. I have never been a big fan of gold. The price all depends on demand and I don’t want to rely on that. Plus, if our currency begins to fall, why would we all of a sudden switch to gold? That hasn’t really ever been the case when other societies have fallen.

    Jake @ Common Cents Wealth

  2. Gold is not an investment because it does not generate any income, it just sits there the same way a stack of dollar bills might just sit there. Therefore, it’s not fair to compare gold to other INVESTMENTS but rather to compare gold to CASH (if you want an investment, try gold mining stocks instead). Since 1913, the value of cash has fallen 98% whereas gold’s value has remained relatively stable (in terms of purchasing power). As a result, holding gold instead of cash over the long-term is a no brainer.

    I disagree with two statements in this article.

    The first one is:

    “More proof of a bubble: all of the cash for gold advertisements you see everywhere. Remember, you know it’s a bubble when EVERYONE is getting in”

    The cash for gold advertisements is evidence of the exact opposite of a bubble. The advertisements are for people to SELL their gold, not buy it. Once you see advertisements to BUY gold, then THAT would be evidence of a bubble. Because so many people have been selling their gold, that means there is not much gold left for them to sell. Once the sellers are exhausted, prices have to go up.

    The other statement I disagree with is:

    “I would not be interested in trading someone my cow for gold.”

    The average fiat currency lasts 27 years and eventually all of them fail.

    Source: http://georgewashington2.blogs.....-fiat.html

    The US Dollar failing to have any value whatsoever is not a question of “if” but rather “when.” When the currency collapses, people will need an alternative. While barter is always possible for a select few transactions, you’re not going to be trading your cow or other things like food, water, shelter supplies, etc on a wide scale basis because these things do not have the traits of “money” like:

    1. durability
    2. divisibility
    3. transportability
    4. noncounterfeitability

    What is most likely to happen is that people will start using gold and silver again for normal everyday transactions. You’ll see those 1964 silver dimes come out in circulation again whereas the 1965 and later dimes will be discarded all together.

    Tommy Z

  3. The other reason would be for a complete financial system collapse. I guess that could go along with a hyper-inflationary type of event…

    But I agree with the above. It is not an investment, it is an asset class. You’re basically converting dollar currency over into another store of wealth (historically viewed that way anyways).

    Derek | MoneyAhoy.com – Money Saving, Making Money, and Investment Ideas

  4. Does it matter why investors buy gold? Does it matter why the price fell?

    Could investors have made money on the way up and down in gold? Yes

    Gold is just another instrument to make money with.

    Think about it….

    Brandon Bruckman

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