Good As Gold?

Last week’s post included this chart:

Among other things, it shows that over the 50 years from 1972 to 2021, gold outperformed inflation by 4.1% per year.

Unlike house prices, which are mostly formed by local supply and demand, gold prices are set by buyers and sellers all round the world. Over time, there have been buyers willing to pay more for the yellow metal. Many of them have been suspicious about the worth of the paper promise that backs banknotes and have wanted something more durable. You can think of them as willing to buy insurance against an Armageddon scenario like Laszlo witnessed in Budapest after the War https://www.dhirubhai.net/pulse/money-just-isnt-what-used-patrick-rudden-17ale/.

Gold has been used successfully as a store of value for millennia. As evidenced by the fact that metal detectorists are still unearthing thousand-year-old hoards, gold is clearly something people have consistently wanted to collect. Some people argue that gold is uniquely suited to protect their purchasing power and they are eager hoarders of the precious metal. On the other hand, there are plenty of people who have remained unconvinced of gold’s allure. Famed British economist, Keynes, dismissed gold as “a barbarous relic”, and legendary investor, Warren Buffett, said, “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it...Anyone watching from Mars would be scratching their head.”

While the attraction of gold as a store of value rather than jewellery may leave some scratching their heads, there is no doubt that gold is one of those collectible things whose price has continued to appreciate. At the start of 1972, gold cost $44 an ounce; by the end of 2021 it was $1,829 – an increase of 42x in US dollars (and at over $2,800, its price is even higher today).

Because gold is global, its price is set in the global currency – US dollars per ounce. Over time, the value of the pound fell, which benefitted British buyers of gold. In 1972 one pound was worth $2.50 but today it’s only worth half that. With the pound getting weaker, something priced in dollars became even more valuable and the increase in gold in pounds, over those 50 years, was 79x. Of course, you weren’t 79x richer if you owned gold because you must factor in the effect of inflation raising prices over time and eroding the purchasing power of your gold. Once you factor in inflation, gold’s purchasing power in pounds increased by 4.1% a year, as shown in the chart above.

The chart by the way isn’t investment advice. It shows past performance. Just because something performed well (poorly) in the past does not mean it will perform well (poorly) in the future. If you are seeking investment advice, I recommend you speak to a regulated financial advisor. There are a lot of them out there. Helpfully, the regulator keeps a register https://www.fca.org.uk/consumers/using-financial-services-register.

With the important caveat that we don’t know the future performance of gold, you may nevertheless decide you want to own some. How might you do that?

You can buy a fund that invests in gold (or another precious metal including silver, platinum or uranium), but note you don’t own the gold. Either the fund owns gold on your behalf, or it promises to match the price of gold it may not actually own. In both cases, you are entering a contract with a fund, who you trust to provide you with the return you would get from buying gold without the inconvenience of having to buy gold. There is another, more recent, way to get exposure to the gold price without the inconvenience of having to buy physical gold and that is by investing in a gold-backed cryptocurrency.

Like gold funds, gold-backed cryptocurrencies offer to match the price of gold without you having to go through the inconvenience of physically buying gold yourself. With a fund, you own shares in a fund, and with a gold-backed cryptocurrency – or digital gold, as it’s sometimes known – you own a coin. In neither case, do you directly own gold. That may be fine for some, but I suspect many people who are drawn to invest in gold actually want to know they directly own some physical gold. If you are one of those, then you will need to explore investing in gold bullion.

If you want to physically get your hands on gold or another precious metal like silver (uranium is a precious metal too but you probably don’t want to get your hands on it), you will need to buy bullion in the form of coins or bars or jewellery. Then you will need to find a safe place to store your bullion – either at home or in a safe deposit box. If you store it at home, you will have to decide who, if anyone, to tell, including whether you want to tell an insurer who will, of course, charge you to protect you against the loss or theft of your gold. If you store it in a safe deposit box, then you may still want to take out insurance against loss or theft. A few years ago, some boxes at Hatton Gardens Safe Deposit in London turned out to be not-so-safe after all – they were burgled, leaving all the uninsured depositors worse off.

Storing and insuring precious metal is costly. Buying and selling it can be costly too, as dealers in gold coins, for example, will – like money changers at the airport – charge a higher price to sell a coin to you than they will to buy the same coin from you.

A cheaper way to own bullion is by buying a share in a gold bar stored in a vault on your behalf. Unlike when you buy bullion to store at home, or in your own safe-deposit box, you will not be able to hold your precious metal. But, unlike when you buy a gold fund, the gold in the bullion vault will be specifically allocated to you. Because it is allocated to you, you will have to pay the cost of storage and insurance but, unlike buying coins from a dealer to store at home, the difference between the price at which you can buy and the price at which you can sell is relatively narrow.

Another way to get exposure to gold is to buy shares in the Golddiggers – the companies that mine the stuff. Mining for gold is a risky business – sometimes you strike gold, sometimes you don’t. Because they’re risky, the stock prices of gold miners tend to do very well when the gold price is going up, and the opposite when the gold price is going down.

Each company will have its own specific risks – for example, some will be mining more in Canada, some in Russia, some in Africa, and each geography has its own unique challenges. You can mitigate the risk that one company might fall on hard times by diversifying your investment across several companies. In the case of gold miners, there are funds that will track a basket, or index, of gold miners, and investing in one of those provides exposure to goldminers and ready-made diversification.

There’s more to say about gold including the disturbing questions of what it means to come off the gold standard and why no President since WWII has been allowed inside Fort Knox. So, as they say, stay tuned.