What is happening with gold?

Posted by Allison on 4 April 2009, 10:04

Gold has always been a commodity that has been taken as a measure of how well things are doing. When things are good then the price of gold is stable, but when things are bad, well it is a whole different story then! It might be reasonable to think that when things are bad, the price of gold would decline, but usually, the converse happens and the price of gold starts to climb, in conjunction with all the other staples that are going up, particularly oil.

This was proved when in the early part of 2008, gold suddenly seemed to go through the roof, hitting an all time high in January 2008, at just over $900 per ounce.

Yet why has gold suddenly taken such a leap, particularly when the cost of oil is so high and the price of food seems to be escalating? Wouldn't it be good if gold were stable, almost as a way of making sure that there was at least some staple of the economy upon which we can rely?

Well, the main reason for the sudden hike in the price of gold has actually been caused by the rising price of both oil and food. Investors want to buy something which will give them a good return and although there has been speculation with regard to both food and oil, the main area of speculation that seems to be happening is with regard to gold and other precious metals.

Gold has been particularly strong in recent years and has effectively gone up by 50% in 2007 alone. This sent very strong shockwaves through the financial markets all over the world and people started to panic slightly about how high the price was going to go. Particularly those who had been considering putting money into gold, but hadn't quite got round to it.

Platinum also started to rise and there really seems to be no stopping the market in gold and platinum, similar to how oil and food are on the up, in terms of price. But will this last, or is gold's bubble about to burst? Will the market suddenly become worthless or will the price of gold just go up and up and up……?

Why is gold important?

Although gold is less valuable than platinum, it is still very much a desired metal. Although platinum is prized and is seen as a luxury item and even a prestigious one at that, gold is still preferred by investors and is also a symbol of wealth when used in jewelry. Gold started being valued as early as prehistoric times and it was seen as a means of showing affluence, wealth and glamour, even in the earliest of civilizations.

There are even some Egyptian hieroglyphs, which date back to 2600 BC (some 4,500 years ago) that paint a very attractive picture of gold and also lay claim to the fact that gold was more common than soil in Egypt at this time.

Gold is even mentioned in the Bible as being something that is desirable and a standard against which things could be measured, assessed or even valued. Most references are contained within the Old Testament, which historically dates back to the period before Christ.

The Romans even mined gold and they were never ones to waste their time on anything that was not of worth. So they had cottoned on to the fact that gold was precious and that it needed to be extracted and preferably in extremely large quantities.

It would appear that gold was first used as coins somewhere around the year 650 BC. This is thought to be the very first coinage that was used in the entire world and was created in Lydia, a country that existed in the Iron Age and was part of Asia Minor, situated close to modern day Turkey. Making gold into the standard used on which to base a coinage, established gold as being something of worth and basically sealed its fate as being something that was not only decorative, but could be used to measure how much other things were worth.

Thus gold has been valued and treasured really since early times. It is interesting that despite platinum, gold is still something that we prize and still value. Gold even has sayings attached to it such as 'He is worth his weight in gold'

It is still therefore very much something that countries want to stockpile, so that they can be sure that they will have something to keep them going during leaner times and if times get better, well they can then buy more gold and build up even more reserves.

What is so special about gold?

Gold is an interesting material because it is a very malleable material in the sense that it can be easily worked and so it is relatively soft to beat into almost any shape or form that is desired.

It can also be easily mixed with other alloys, so that gold can be made more durable. Jewelry made from gold is more durable if it has other metals attached. If an item is 'pure gold' then for obvious reasons, it really would not be suitable for day-to-day wear. It needs to be mixed with other metals so that it can last and does not wear too much.

It is also a very dense metal that weighs heavier than lead, even though people assume that gold is not heavy in the way that lead is. However, this may simply be because people do not see large quantities of 'raw gold' we usually see it after other metals have been attached and we have made it into some jewelry or other finery.

Gold is also rare enough that it will not flood any market. If it were a metal that anyone could simply dig up, then obviously it would be no use as some kind of standard. The fact that it is rare and indeed getting rarer and is not easy to extract, means that it is not readily available and thereby it is an excellent metal to use as a standard for monetary exchanges.

Use of gold in coins

Since the early use of gold in coins used in Lydia, gold has really been used almost constantly as a form of currency ever since. Even if it were not in the coins, then the coins may be worth 1 ounce of gold and so on. So it has been associated with money (and wealth, or lack of it) for over 2000 years.

From the early 16th Century, in the United Kingdom, gold was made into coins, which were mixed with other metals to produce a coin known as 'crown gold'. These replaced standard 'pure gold' coins, which unfortunately were so soft that they were difficult to use, since they were subject to wearing down very quickly!

It is now pretty standard practice that gold is simply too precious a metal to be used in coins. Although historically, if it were used, then gold was mixed with copper, so that it would become more durable.

Use in Monetary Exchange

The use of a 'gold standard' was common practice in fiscal markets, until the 20th Century. This is a system whereby coins and notes are issued and they are then convertible into a set amount of gold.

The issuer of the currency requires the same amount of gold, or the ability to get it, than is issued in notes. So for example, a currency is issued whereby 100,000 x $ 1 notes are issued and each notes is worth .10 of an ounce of gold, the issuer would need to be able to have 10,000 ounces of gold available or attainable, if each note were to be redeemed.

Although the gold standard is not used any more, it was a popular standard. However, fluctuations in how much money could be mined every year meant that periods of inflation were experienced. It is also quite an intransigent standard, so that an economy may find that it is simply not flexible enough to meet its particular needs, particularly when the price of something like oil starts to fluctuate or inflation starts to creep in.

Use of gold as a reserve

Gold is used now mainly as a reserve. Many countries hold gold reserves and it is seen as a valuable way of protecting a country's currency. This is particularly the case when the US dollar is at a weak point. Since the US dollar has been weak since 2006 and in 2008 it shows no sign of regaining its strength, then nations buy gold. Usually they would buy US dollars, but until the dollar stabilises, gold is seen as being preferable to the US$.

Most central banks will also have gold as one of its main assets. These are often used as collateral against which internal loans are made within governments. So if a government department needs a sudden rush of money to resolve an issue, then the loan can be issued against the gold that is held in reserve, although this is usually only used in periods of relative crisis. Around 25% of all the gold in the world is held by central banks in the form of reserves.

Due to the fact that the price of gold can be volatile and that if too much gold is on the market, it will affect how much money a country has in reserve, an agreement was signed in 1999 by the European Central Bank which was designed to stop gold being sold as a means of raising capital and also as a way of stopping gold being leased out as a way of speculating on its price.

Gold is also bought by private investors, often in the form of gold bars or even gold coins. This is a way of buying something that is seen as a relatively safe bet, after all, gold has been an important part of culture, since the earliest of times and so it is extremely unlikely that it will actually become worthless.

This accounts for just why the price of gold is so closely linked to that other precious commodity oil. Whereas oil is effectively a necessity and is something that we desperately need and indeed western civilization cannot do without it, gold is actually a luxury product. After all, people could actually go about their daily business without gold, as many people in fact do.

However, when the price of oil is high, then speculators cannot buy it as easily, since if they do and the price drops, then they will be left with a surplus of oil, or they will have to sell at a loss. Since no one wants to make a loss, investors will look around for something else that they can buy and then not just recoup their money, but also make a profit on.

After the bottom fell out of the housing market in the US and then throughout Europe, gold once again seemed a much safer option and one where the risk was minimal, hence why even when the price of gold starts to go up, investors will still back it.

Gold is seen as an ideal investment, since it is unlikely to lose significant amounts of value. The other thing about gold is that it has no shelf life. Investors can buy gold in 2008 and then, unless they need the money, hang onto it for another 10 or 15 years. This gives it a real strength, since many investments are actually much more risky over the longer term, whereas gold is seen as something that is much more of a safe bet. In fact it is a way of hedging your bets (hence the term hedge funds) and as such is a very valuable commodity, even thousands of years since it was first prized.

How high will gold go?

During 2007, speculation in gold reached an all time high. In fact a massive 630 tons of gold were bought as speculation funds. This is the largest amount ever bought in this way, ever. As a result the price of gold rocketed and even as it started to climb sharply, people still backed it, such was the fear, if not panic about Real Estate and oil.

Some investors think that the price of gold will actually reach $1500 per ounce in the late part of 2008 or 2009. This is double what it was in early 2007, so it is a significant rise.

However, ironically if the price of gold goes up to that price, then it will start to become a riskier bet, this would be a tremendously high figure for gold and if it did stick at this level or around this level, then it would be difficult to project a significant profit on any quantities of gold bought.

The difficulty is that so much gold has been bought speculatively. So people will buy gold and then keep an extremely close eye on how it is performing. There is then a real danger, that if it climbs up to $1500 per ounce, then the speculators will all dump their gold on the market, thinking that it will never get much higher than this. So what happens next? That's right, the price of gold starts to decline because the market is semi-flooded and demand is outstripped by supply.

The IMF announced in April 2008 that it was going to sell off some of its gold supplies in order to try and balance its books. Hopefully it will not simply dump the 12.97 million ounces of gold that it has onto the market overnight. The gold that it is selling is worth somewhere in the region of $6 billion. This could seriously affect the markets, unless it comes in at a steady rate.

So this could either be a good thing or a bad thing for investors. It will be a good thing if it is gradually slipped onto the market. This will keep the price of gold relatively stable and still affordable to many investors. Obviously the negative aspect to this issue is only if the IMF just floods the market with gold. However, given that this is the IMF who are dealing in gold and they act as the watchdog for the world's economy, it is extremely unlikely that they would seriously play around with the market in this way, particularly when economies are so fragile because of the dollar and the price of oil as well as the rising price of food.

Fool's gold

Buying gold is obviously a risky business and like any investment where people hope to make money, there are associated risks. However, many investors still love the concept of putting money into gold and are likely to continue to have a love affair with gold for a long time to come.

The market for gold is a serious and competitive one and at times quite a ruthless one, so one thing is clear, gold is not for fools, but only the serious and wise investor.