Investing In Gold

For the first twelve years of the twenty first century, we did not see a single year in which the price of gold did not increase, when compared to the previous year. This is not just a statistical curiosity — it tells us about the general trend of increasing gold prices during this time.

There are a number of reasons why gold has been rising for the last twelve years. We will look at the reasons for its rise, and investigate whether investing in gold is a profitable venture or not. But first, let us first investigate why gold is so valuable.

American Buffalo ProofProperties of Gold that make it Valuable

One of the qualities of gold is that sets it apart from so many other metals is that it does not easily form any compounds. If you go to an iron mine, you will not find iron in that mine. What is present in that mine is a compound of iron, such as Ferrite. However, if you went to a gold mine, you can actually find gold nuggets in the mine.

Since gold does not form compounds with oxygen or any other element, it is found in its natural state. This property of not being susceptible to chemical bonding with other elements is called inertness. It is due to gold’s inertness that we can store gold in vaults for decades without worrying about its degradation.

Another property of gold that makes it valuable is its luster and color. In most cultures, gold’s yellow color is so engrained in everyone’s mind that the color of gold itself is a symbol of wealth. Even if you did not like gold aesthetically, this association of gold with wealth will make it seem attractive to you.

Gold is also malleable and ductile, which makes it easy to work with it. Traditionally, a single goldsmith made all the ornaments or jewelry in his shop using just his instruments, proving for us that gold is easy to work with. Finally, the biggest reason why gold is valuable is that it is one of the rarest metals known to us.

Why do Gold Prices increase in the Long Run

President NixonHistorically, gold has served as a currency because of its rarity and value. In fact, currencies of the world were convertible to gold by a pre-determined amount till the year 1971, when the American administration under President Nixon ended the convertibility of dollar to gold.

Till the 1971, gold prices kept pace with inflation because the value of dollar itself was denominated in gold. However, after the dollar was delinked from gold, gold’s value has increased relative to dollar because dollar has been depreciating due to inflation and other factors.

In today’s monetary system, central banks can introduce any amount of currency into the market because these currencies are issued by the fiat of the banks themselves. This directly influences gold prices, because if a lot of central banks issue extra currency, these currencies will devalue, and they will devalue relative to gold. This increases the price of gold.

In fact, this is already happening due to the policies followed by the Federal Reserve Bank of the United States, as well as by the policies followed by other central banks. This policy of devaluing the dollar by releasing more dollars into the financial market is termed Quantitative Easing, and till now the Federal Reserve Bank has launched three rounds of Quantitative Easing.

Quantitative Easing Part X

The Federal Reserve Bank started its policy of what is called Quantitative Easing after the 2008 financial crisis. Under this policy, the Federal Reserve buys security instruments from private financial banks and institutions. This introduces extra dollars in the monetary system.

Printing MoneyBy introducing more money in the system, the bank hopes to facilitate lending and borrowing, which is essential for the healthy functioning of any capitalist economy. However, one of the direct results of introduction of dollars in the economy is that dollar slowly becomes devalued.

Part of the job of the Federal Reserve is to make sure that it only releases enough dollars to help the economy, without harming the value of the dollar. However, this does not stop dollar to be impacted at least a little bit.

There have been three rounds of quantitative easing from the Federal Reserve in the last four years, and all of them have led to an increase in the prices of gold and silver. During its announcement of the third round of QE in September 2012, the Federal Reserve bank said that it was going to buy $40 billion worth of housing securities every month. This meant that in an year the bank could end up introducing about $480 billion worth of dollars in the economy, which would reduce its value relative to gold.

Gold is a precious metal, and always has been, because of its aesthetic value, as well as because of its rarity. It has proven itself as a standard of value for centuries, and even today most central banks own tonnes of gold as reserve to give value to their currencies.

Further, the latest policies followed by the US Federal Reserve Bank are only increasing the value of gold as we speak. If you are a long-term investor, you should definitely have at least 10-20% of your portfolio in gold by investing in gold. Gold not only appreciates over time, but also serves as insurance against a bad economy and worse times.

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