The idea that gold preserves wealth is even more important in an economic environment where investors are faced with a declining US dollar and rising inflation due to rising commodity prices.
Historically, gold has served as a hedge against both of these scenarios. With rising inflation, gold typically appreciates. When investors realize that their money is losing value, they will start positioning their investments in a hard asset that has traditionally maintained its value. The 1970s present a prime example of rising gold prices in the midst of rising inflation.
The reason gold benefits from a declining U.S. dollar is because gold is priced in U.S. dollars globally. There are two reasons for this relationship. First, investors who are looking at buying gold (like central banks) must sell their U.S. dollars to make this transaction. This ultimately drives the U.S. dollar lower as global investors seek to diversify out of the dollar. The second reason has to do with the fact that a weakening dollar makes gold cheaper for investors who hold other currencies. This results in greater demand from investors who hold currencies that have appreciated relative to the U.S. dollar.
Gold as a Safe Haven
Whether it is the tensions in the Middle East, Africa or elsewhere, it is becoming increasingly obvious that political and economic uncertainty is another reality of our modern economic environment. For this reason, investors typically look at gold as a safe haven during times of political and economic uncertainty. Why is this? Well, history is full of collapsing empires, political coups, and the collapse of currencies. During such times, investors who held onto gold were able to successfully protect their wealth and, in some cases, even use gold to escape from all of the turmoil. Consequently, whenever there are news events that hint at some type of uncertainty, investors will often buy gold as a safe haven.
Gold as a Diversifying Investment
The sum of all the above reasons to own gold is that gold is a diversifying investment. Regardless of whether you are worried about inflation, a declining U.S. dollar, or even protecting your wealth, it is clear that gold has historically served as an investment that can add a diversifying component to your portfolio. At the end of the day, if your focus is simply diversification, gold is not correlated to stocks, bonds and real estate. (For more insight, read The Importance Of Diversification.)
Different Ways of Owning Gold
One of the main differences between investing in gold several hundred years ago and investing in gold today is that there are many more options to participating in the intrinsic qualities that gold offers. Today, investors can invest in gold by buying:
Gold Mutual Funds
There are advantages to every investment. If you are more concerned with holding the physical gold, buying shares in a gold mining company might not be the answer. Instead, you might want to consider investing in gold coins, gold bullion, or jewelry. If your primary interest is in using leverage to profit from rising gold prices, the futures market might be your answer.