King Midas and the Golden Touch
King Midas wished everything he touched would turn to gold but after Dionysus granted him his wish, Midas soon saw the foolishness of his wish and asked Dionysus to release him the curse. To do so, Dionysus had Midas wash in the Pactolus River (in modern day Turkey). This is the mythological source of the real gold present in the river
Gold has been the subject of many myths and legends throughout history and it is clear that it has always been considered very valuable. Historically gold was often used as a currency and when paper money was introduced it was regarded as a receipt convertible to fixed quantities of gold. In the monetary system known as the Gold Standard, the value of gold was used as a standard for many currencies. In 1934 a troy ounce of gold was valued at $35 US. At this rate, foreign governments and central banks were able to exchange dollars for gold. Bretton Woods established this system of payments based on the dollar, in which all currencies were to be defined in relation to the dollar, itself convertible into gold. The U.S. currency was now effectively the world currency, the standard to which every other currency was pegged. The gold standard was abandoned in the 1970s and gold was left to find its own free market level. Nowadays banks still hold gold reserves as a store of value but currencies no longer need to be backed by gold.
Gold is no longer used as currency and is now classified as a commodity. A commodity is generally defined as a good which is the same regardless of who produces it . Thus oil, gold, wheat are commodities whereas stereos are not. However. gold is not being priced as a commodity, people will pay a lot more for Gold than its commodity value.
WHY BUY GOLD?
Since 2001 Gold has tripled in value versus the USD. but gold is not defined as a currency. It is not classified as an energy resource, or a foodstuff. It does look good as jewelry and in assorted ornaments and generally everyone agrees that it is valuable. Yet with traders so willingly investing such huge amounts of money in Gold, what are they buying exactly?
Gold is not consumed like petrol or foodstuff. It is not “useful” like aluminum and copper. It is estimated that in the history of mankind about 161,000 tonnes of gold have been mined just enough to fill 2 olympic- sized swimming pools. For the past 30 years the rate of growth of gold extractions from mines has matched the rate of the world’s population (roughly 2000 tonnes/year). Gold quantities remain constant because gold is not truly “consumed” . It simply gets recycled again and again because it has always been too valuable.
What are the investors buying exactly?
Like any other commodity the price of gold is determined in large part by supply and demand. However the demand for Gold is not the same as the demand for oil and copper. The increase in the demand for Gold invariably indicates that the more conventional types of investments are not producing the kind of returns needed to protect the wealth of investors. Investors do expect a certain after tax return on their investments, and if it cannot be obtained in one type of investment they will seek it in another. The idea being always that once inflation and taxes are factored into the equation, an investor must see a positive return on his investment otherwise he would see his assets and purchasing power steadily diminishing in value and that is,of course, untenable in the long run.
Gold as a “store of wealth”
While it is true that inflation, the stock market and foreign exchange rates affect the price of Gold, this is true in a certain given investment context. One has to refrain from being too literal in this interpretation. Hence just because the cost of automobiles has quadrupled in the past 30 years it does not mean that the price of gold must also quadruple to offer a hedge against inflation.
The demand for gold is a demand for a hedging instrument against inflation and the collapse in value of other types of investments. Gold fulfills this unique function by allowing investors to invest in an instrument that protects their wealth and purchasing power. The increase in the price of Gold is not haphazard. It is not simply a case of gold “fever” or speculation that drives up the price of gold. Gold plays a unique role in protecting the investors’ capital against devaluation and as such its price will increase in the amount needed to preserve an investor’s purchasing power
CONTROLLED EUPHORIA
The price of gold can increase and increase a lot, however it is always in a controlled fashion. if that were not the case then gold would not play the role it plays in the preservation of investors’ purchasing power. Because gold is a hedge against inflation and the loss in value of other assets, the price of gold must move in a direction opposite that of other assets. Because gold is there to preserve the value of investors capital when other investments classes are losing value, its price has to vary inversely to that of the main types of financial assets.
The required yield theory states that the after tax return earnings on investments must be viewed as minimum return equal to the GBP/capita long term growth rate plus expected inflation rate.The 1.5% constant turns out to be the long-run average real GDP/capita growth rate in major developed economies. In the US the historical long-term average GDP/capita growth has been 2.03% from 1929-2006. (see http://papers.ssrn.com/sol3/papers.cfm?abstract_id=520382)
Now a decrease in the stock market alone is not sufficient to drive investors to invest in gold. However a decrease in stock market earnings combined with high inflation and taxes would certainly incite investors’ to consider investing into gold. The increase in the price of gold is imminent only if the combination of high inflation and taxes and a decrease in earnings from the other main investment types are present. Gold increases in price only to the extent that its function is to preserve the wealth and purchasing power of investors, and anything else would defeat its purpose. The exception to this rule occurs in the case of war and when some countries default on their payments, However the effect there is merely temporary.
About the Author
Article courtesy of The Parrotster Forex & Currency Trading
