Humans have considered gold and other precious metals as valuable resources for centuries. Even though the price changes, the general effect on its value makes it a safe and smart investment. However, this doesn’t mean the yellow metal is appropriate for all portfolios. People who want to invest in gold should take note of some misconceptions to enable them to make the best decision on the market.
Gold remains valuable due to its scarcity and high demand. The metal is beautiful and does not corrode. It is no wonder it represents wealth in many societies. Aside from its outward magnificence, it is also an excellent way to store value and preserve wealth. The gold standard provided the early point of reference for currencies.
Additionally, governments and banks cannot freeze your gold when they want to control you. This is different from gold Exchange Traded Funds and gold mining stocks which are also products of the precious metal but have more restrictions.
Investors buy gold because of its intrinsic value. The idea is that the price of the precious metal rises because of significant demand to give investors a healthy return. However, the value of gold doesn’t behave that way. Physical gold fluctuates just as stocks and bonds.
What you should understand about holding gold is that the precious metal is a storage value, not an investment. You should not purchase gold expecting future earnings or for its growth prospects. Gold is only good for retaining your purchasing power.
Inflation is the perfect example to explain this. When there is an increase, it reduces the value of currencies. This is different for gold. The ability of gold to preserve value can help an investor offset the loss of the currency’s value during inflation.
How does the price of gold react to the various economic conditions? The points below will provide more information on this.
Gold and recessions have had an inverse relationship for a long time. Prices increase when an economy weakens because several investors turn to it to preserve their wealth in a looming recession.
However, investors should not always assume this. There have been instances in 1980 when the prices dropped during a recession. Always consider the risk tolerance when buying gold.
The value of gold increases when inflation increases. This is because investors consider the metal an excellent hedge against inflation. The demand makes it a more valuable asset when currencies lose value.
Like the recession, this is not always the case. There have also been instances when gold has performed poorly when inflation was high. This knowledge is the reason why some financial advisors are critical of the perception of using it as a hedge against inflation.
However, the issue with this type of analysis is that the research that provided the statistics backing the assumption considered the inflation rate and gold prices alone. To establish causation, a person must look at the entire economic picture to enable them to go beyond proving correlation.
During the period under consideration, the government cut taxes and eased several financial regulations. It also reduced spending on social programs and focused on the military. This led to Americans having more money to spend even though they were in a recession. Investors, therefore, had no strong demand for physical gold or other precious metals.
The general perception is that there is an inverse correlation between the price of gold and interest rates.
Investors prefer buying low-risk investments such as bonds when interest rates are high because of the higher yields. Most of them readily dispose of their gold to buy more bonds that take advantage of the high-interest rates. Less demand reduces the prices of gold across markets.
The US dollar is widely accepted as a common trading currency between most countries on the international front. When it weakens, it affects the price of several commodities globally. Gold prices increase when the dollar weakens because the gold is traded in dollars. A weak currency makes gold cheaper for foreign investors, increasing the demand. This drives the price of gold up.
However, this relationship is not a perfect inverse correlation.
The price of gold and the stock market have a negative correlation. It means when the stock markets are performing well gold prices usually fall. This is because demand shifts to stocks when they are doing well.
Also Read: Impact of Economic Events on the Gold Market
It is good to buy gold when a recession is looming. The prices remain low before the recession. However, this will rise when the recession hits, increasing your wealth.
When you buy gold it also diversifies your portfolio and minimizes your financial risk and reduces the chances of losing your wealth during economic hardships. Gold helps to counteract shocks that you might suffer during this period as it generally moves in the opposite direction as stocks, bonds, and other assets.
There have been many reports pointing to an economic downturn amid the pandemic and geopolitical wars.
This is a good time to invest in gold to help you protect your portfolio regardless of what happens.