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Investing in gold has become a much more popular idea in todays world with the global recession. Before deciding whether a gold investment is right for you, consider the pros and cons of investing in gold. This article will examine this history of gold as an investment, the sources of demand for gold, why investors typically choose to invest in gold, and the types of risk that are inherent in different types of investment.
History of Gold
The first known mining of gold was by the Egyptians approximately 2000 BCE, and the first coin minted that included gold in its composition was made during the eighth century BCE. The first pure gold coins were struck at the order of King Croesus of Lydia who reigned from 560 to 547BCE in what is now modern Turkey. Since the time of King Croesus, pure gold has been used as a form of currency throughout the world. Currently the annual production of gold is relatively stable with no foreseeable increase due to lack of exploration and mine development. Current mines that are developed replace the production of mines going out of commission, producing a relatively flat outlook for future gold production. Currently, banks account for the holding of approximately 20% of all above ground gold resources.
The market and sources of demand for gold are fairly stable. Currently the jewelry industry accounts for approximately 68% of the annual demand for gold. Financial investment accounts for around 19% and the remaining 13% is used within the technology industry as gold is an excellent conductor.
1 Troy oz. of Gold
General Reasons for Investing in Gold
Usually people choose investing in gold for two broad and very different purposes. The first reason is to earn profits trading gold over the short term to capitalize on any short term increases in gold prices. The second reason, and possibly more important reason in today's economy is as a protection of wealth. Gold has historically held its value despite inflation, changing politics, and any market problems that arise because it is inherently different than investing in stocks, bonds, or foreign currencies.
Pros and Cons of Investing in Gold - How Gold Stacks Up Against Risk
Types of Investment Risk
Investing in Gold - Credit Risk
There are generally three types of risk that are involved in making an investment. The first is a credit risk. Credit risk is the risk that a debtor will not pay such as with mortgages. One of the pros of investing in gold is that this risk does not apply. Gold is not a liability to anyone. Unlike currency investment, gold is not effected by any country's issuing policies or economic policies.
Investing in Gold - Liquidity Risk
The second type of risk is liquidity risk. This is the risk that when you wish to sell the commodity in question, a buyer will not be found. Gold is constantly in demand all over the world and thus has a relatively very low liquidity risk because of 24 hour trading and a wide range of buyers from other investors to the jewelry and manufacturing sectors. In addition, there is a wide range of investment options for gold including coins, bars, jewelry, futures and options, exchange traded funds, and certificates.
Investing in Gold - Market Risk
The last type of risk involved in making an investment is market risk. Gold is subject to market risk, but many of the cons to investing in gold are very different than other investments which actually enhances investing in gold as a way to diversify your portfolio. The risk to gold prices happens in the short term when a rather large investor decides to liquefy a substantial amount of gold rather quickly. While the price of gold would be effected in the short term, because of the stability of gold production, it is unlikely to have any impact on equity returns. Likewise the risks that are inherent in bods and equities during an economic downturn do not apply to investing in gold. One simple measure of the market risk of a commodity is the volatility of the market. The more volatile a market is, the riskier it is to invest in it. Historically gold price is less volatile than any other commodity prices. Any sudden increase in demand for gold can usually be met with relative ease because of the large above ground stock of gold - of which nearly 20% are held by banks.
Pros and Cons of Investing in Gold - Conclusions
In conclusion, the pros of investing in gold derive primarily from the differences between gold investment versus other types of investment. Investing in gold incurs no credit risk, very limited liquidity risk, and a different type of market risk than stocks, bonds, or foreign currencies. Gold can be traded either in the short term or used as a protection of wealth as gold is not subject to inflation in the manner of paper currencies and gold's value is not based on the economic whim of any country.
An interesting question was posed in November 2005 by Rick Munarriz of Motley Fool .com as to whether a share of Google or an ounce of gold were a better investment. At the time, both were valued near $700. As of this writing (6-12-2009), a share of Google closed at $424.84 USD while the current gold price per oz. In USD is $939.10.
PROS AND CONS OF INVESTING IN GOLD
Reasons to invest in gold
The price of gold has been going down since 1980, and gold is cheap. If you are a contrarian investor who believes in buying when prices are low, now could be a good time.
Once the price of gold starts to rise, banks which have large gold reserves will not want to sell it cheaply.
Several gold funds have hit yearly lows, so a pick up may be imminent.
The American economy could be slowing down. A decline in the value of the dollar could lead to soaring gold prices.
Consumption of gold has exceeded production for the past 8 years, and with gold prices dropping; some gold mines have decided to scale back production. This could lead to an eventual upswing in the price of gold.
With Asian countries recovering from the financial crisis, gold demand is picking up.
Reasons not to invest in gold
Price of gold has been mostly going down since 1980
Central banks have tonnes of gold bullion which they could sell at anytime, thus flooding the market and bringing down prices even further.
Gold funds have not been doing well for a long time.
Even though gold funds are less volatile than investing in gold per se, it still is a risky investment.
Investors must contend with brokerage fees, dealer markups, and storage and insurance costs (if you're buying a lot of gold).
Gold bullion or coins do not produce yields the way bonds and stocks do.