Gold is one of the most popular investment vehicles in the world, sparking the imagination of people everywhere. For thousands of years, gold has been one of the most sought after materials on the planet. It was the foundation of most of the world’s monetary systems since the first gold coins were made in Greece in 700 B.C. up until Nixon took the United States off the gold standard in 1971. The metals properties are both strange and wonderful, as it resists individual acids, doesn’t tarnish, and is so remarkably malleable that a single ounce can be beaten out to a sheet with an area of 300 square feet. People remain obsessed with it even today despite the absence of a real, practical value, something we could call the Treasure of the Sierra Madre factor.
Of course, the wild world of investing in gold can be baffling to the uninitiated. Take the last few weeks when gold plunged 2.7 percent when one Federal Reserve Bank President made a comment to the press about quantitative easing, only to gain back 1 percent exactly seven days later when, wait for it, a different Federal Reserve Bank President made a comment to the press about the same subject. For major gold investors, these are moves that could means millions of dollars made or lost, all hinging on the conflicting opinions of two members of the same organization.
Ultimately, gold can be a confusing investment vehicle. However, a broader understanding of this precious metal, where it comes from, and how its price is connected to macroeconomic policy can help make things more clear.
It’s a Gold Mine
Gold is a commodity. Which sounds like a real "duh" statement, but given the way its price tends to move more like an investment vehicle, it can be easy to forget. It’s mined, meaning that it’s still subject to at least some of the price pressures that come from basic supply and demand.
And most agree that gold’s supply isn’t keeping pace with demand. Not by a long shot. Between industrial uses, jewelry, and buying by central banks and investment vehicles (like ETFs backed with physical gold), demand is steadily increasing. However, with about 160,000 metric tons of gold currently existing above ground and an average of about 2,400 metric tons being produced each year, the supply only tends to tick up about 1.75 percent annually.
The last six years have seen a fairly radical shift in the world’s biggest gold producers. As of 2006, South Africa was the largest gold producer in the world, mining 272 metric tons out of 2,360 metric tons of global production. But, by last year, the African nation had dropped to 5th, with its production dropping to 170 metric tons and Russia (205 metric tons), the United States (230 metric tons), Australia (250 metric tons), and China (370 metric tons) all passing it in total production.
The world’s biggest gold mining companies are publicly traded for the most part, with Canadian companies Goldcorp, Inc. (GG) , Barrick Gold Corporation (ABX) , and Yamana Gold, Inc. (AUY) leading the pack. Among the world’s other major gold-mining stocks are America’s Newmont Mining Corp. (NEM) , South Africa’s AngloGold Ashanti Ltd. (AU) , and Rangold Resources Limited (GOLD) of the Channel Islands.
Gold Price Tied to Markets
However, unlike a metal like iron, where price fluctuation is based almost entirely based on supply and demand, gold’s price moves more in relation to the global economy than anything else. Unlike iron, which is pretty much only bought or sold for completely utilitarian purposes, people buying gold are primarily using it for everything from investing to outright speculation.
Traditionalists tend to view gold as a hedge against market volatility. Simply put, during times of turmoil when investments like stocks (or even bonds) appear to have increased risk, gold is viewed as a safer place to store one’s money. Gold doesn't expected offer returns, according to this line of thinking, but it’s as a safer bet. So, during periods where the global economy appears unsteady, some investors turn to gold as a way to park their cash during tough times.
Gold’s also often seen as a hedge against the dollar. This is based on the belief that gold can maintain its purchasing power when paper money’s declines. That’s the view behind the fluctuations related to the comments from the dueling bank presidents. The Federal Reserve’s bond-buying program has generally been viewed as weakening the dollar (even though the major inflation gains predicted by some haven’t quite materialized), so gold’s price dropped when investors believed the program would be tapered and popped when they were given reason to believe it wouldn’t. However, the connection between gold and inflation may not be as steady as some would have you think.
IS Gold a Safe Haven?
All of this may make one seriously question whether gold really deserves to be viewed as a safe haven or a hedge against inflation. Price fluctuations can come hard and fast and seem to be connected a stream of economic news that can border on random. And to some degree, that’s true. The mere fact that many in the market believe that gold is a way to hedge inflation means that some investors and traders will buy more when the dollar appears weak (or headed that way), which will push up the price. And its perception as a safe haven means that some investors will buy up gold when the market appears to be entering a period of increased volatility, pushing up the metal’s price.
And as a result, these rapidly moving prices can give investing in gold the perception of being risky. Meaning that some traders and investors may sell their gold holdings at a time when they're looking to shed risk, causing its price to drop. So, yesterday when the government shutdown started and one might reasonably think that there would be reason to anticipate a weaker dollar and more volatile market in the near future, the price declined. Go figure.
The morale of the story is that perception has a lot to do with the market for gold, much like it does for other markets, and that means gold prices can move independently of either or both factors. While the primary consideration driving price typically seems to be the value of the dollar, it’s only one of a basket of issues to consider. And depending on what's happening on other fronts, the price can move independently of inflation concerns
How to Invest in Gold
Should one feel like jumping aboard this train, there’s a few ways to go about it. Firstly, you can buy physical gold. While the appeal may seem obvious (you would be like a pirate!), the downside is that it’s totally impractical (holy crap, this is SO heavy!). Physical gold is an extremely inflexible investment vehicle. If you have a gold brick worth $100,000, you’re not really in a position to divest yourself of a third of your gold position.
Gold futures contracts are another option, but, again, not one that's practical to the retail investor. The solution? The good, old, trusty ETF. There are a few options for gold ETFs that closely match the movement in gold prices, with the SPDR Gold Trust ($GLD) and the iShares Gold Trust ($IAU) being among the most popular. Of course, there are also options for gold bears that move inversely to gold prices, and leveraged ETFs in both directions that offer the chance for much bigger gains (or losses). And, one could also invest in ETFs that track the stock of gold mining companies, like the extremely popular Market Vectors Gold Miners ETF ($GDX).