Is Gold Really the Safest Investment?

Is Gold Really the Safest Investment?

Gold is on the move. As the price of gold threatens to push permanently
above $1000 per ounce, it raises questions about why gold is becoming such a
hot commodity and whether it truly is a safe harbor.

There is no question that gold’s price run up is purely speculative. Since
the beginning of 2009, the number of outstanding shares in the SPDR Gold
Trust , the most popular exchange-traded gold fund, has already
climbed about 33%. Demand for gold has increased significantly.

But why At such high prices, gold ceases to have much practical use. There
is no theoretical rationale why anyone should even want to invest in it.
Gold has value only because we believe that it is valuable. It is a
collective hallucination.

There is something else which we use every day that, like gold, has no
inherent value: cash.

Of course, there’s a major difference between gold and cash: Unlike the
dollar, the United States government is not going to impact the non-dollar
value of gold significantly — only its price in dollars via the government’s
impact on the dollar.

And currency explains why gold has not yet made a clear jump above the
historic high set a year ago — in U.S. dollars, that is. The dollar has
appreciated enormously during the global economic slowdown. All else being
equal, this lowers the price of gold for U.S. investors buying with dollars.

Independent of the dollar, gold has actually increased considerably in
value. Indeed, the prices of gold in Euros, British pounds, and Canadian
dollars set their all-time highs, by a large margin, in 2009.

The supply of gold is also a factor in pricing. Many investors holding gold
reserves have faced losses in their other assets, which would have led them
to sell their gold. Ordinary people, too, have motive to sell their gold
jewelry during a recession, which should increase the supply of gold on the
open market and impede a price hike.

As a parallel, much of oil’s decline in prices since the summer arose from
speculators’ unwinding their positions, as they needed to liquidate to cover
losses. But gold prices have not followed oil prices downhill. It is clear
that new money has entered the gold market. Many who sold their stocks and
other assets have reallocated into the gold market, instead of leaving it to
cover losses.

In the face of appreciation of the dollar and a financial meltdown, dollar
denominated gold has still managed to hang in there, near its high.
Speculation remains rampant.

But the speculation in the gold market is nothing like speculation in other
markets. Unlike oil, gold is not consumed, and even when it is used in
products like jewelry, it is recoverable and thus maintains its value as the
gold that went into it. In other words, the total supply of gold is
increasing with gold mining.

Most speculation is motivated by the desire for profit. It seems that
recent interest in gold is instead motivated by the desire to maintain
value. After all, the price of gold in dollars has not shown a steady
return. As the government continues to enact costly but
what many believe to be inadequate solutions to the financial
crisis, investors fear the worst for the future of the economy and the
future of the dollar. Thus, the price of gold has become a measurement of
confidence in the government to handle the crisis.

Traditionally, gold has been a store of value when citizens do not trust
their government politically or economically. In Asia, ordinary people —not investors by any means — have historically held tremendous amounts of
gold in jewelry. Now that same concept has extended to more sophisticated
investors, who do not hold gold in jewelry, but instead in bars and
derivative contracts.

Gold, then, can be considered a currency, unique in that it is not directly
tied to any country’s economy. With a global recession that is bound to
continue to shake up the purchasing power of all foreign currencies, gold is
safer than cash from political and economic instability.

So is it time to put all of your money into gold That depends on your
appetite for risk. The sheer amount of speculation in gold and uncertainty
in the foreign exchange market will keep gold prices as volatile and
unpredictable as ever. Like any financial market, the gold
market is susceptible to manipulation.

But a small percentage of your assets in gold could serve as a hedge against
an exacerbated crisis. At the very least, hold onto your jewelry .

Read TIME’s 1998 cover story on the future of hard currency

Read about Swiss banks