Approximity: A brief introduction to gold - FAQ

What is gold?
Why is it expensive?
Why is gold more than just another precious metal?
How much gold is there?
What is gold's role today?
How is gold doing financially?
Is the financial importance of gold controversial?
How to invest in gold?
Disclaimer

What is gold?

Gold is a comparatively dense, shiny, yellow metall. As an element, gold is quite resistant to corrosion (by oxygen, but also many other chemicals). There are medical (dentistry), chemical and industrial applications of gold (see also the entry for gold in Wikipedia). However, aside these rather limited applications (for which, in fact, gold often can be substituted with other materials like copper, ceramics etc.) the metal is more or less useless.

Why is it expensive?

Despite its relative uselessness, it is wellknown that gold is comparatively expensive (e.g. when compared with the same amount of iron or copper). So, why (at least over the last couple of thousand years) has humanity perceived gold as one of the most expensive materials on the planet? The reasons are in fact very simple: gold is rare, gold cannot be created (synthesized under economic costs) and, as mentioned before, it is shiny and does not oxidize. The latter property made gold an ideal material for jewellery and other representative uses. The evergrowing demand for jewellery and the rareness of gold hence determined its price. In return, the high price made gold an ideal store of wealth. In today's prices (Feb 07, 2007), one kilogramm (around two pounds) of gold is worth around EUR 16,000 (equivalent to GBP 10,600 or USD 21,000). One kilogramm of gold would have the volume of a small bar of chocolate and could easily be stored under your pillow or on the ground of the fish pond in your garden (no packaging required).

Why is gold more than just another precious metal?

As gold was perceived as an ideal store of wealth, its importance as a medium of exchange in trade grew. Finally, this lead to the invention of gold currencies. However, instead of exchanging real gold coins, it would be enough to only exchange the right on or the promise of a certain amount of gold. Paper money was born. As a relict of the times when currencies were backed by gold, many financial institutions (central banks, the IMF etc.) hoard large quantities (several thousands of metric tons) of gold until today. Up until 1971, the US-Dollar was one of these gold backed currencies. Since many other countries linked their own currencies to the Dollar by more or less fix exchange rates, gold was de-facto the world currency.

How much gold is there?

The amount of gold that has been found or dug out in human history is estimated at 120,000 to 140,000 metric tons (1 metric ton = 1000 kilogram). This amount of gold would fit into one massive cube with edges of a length of 19 meters (imagine a cubic 6-storey house made of massive gold). Around 20-25% (30,000 metric tons) of this gold is hoarded by central banks. The rest is privately owned jewellery (70,000-80,000 metric tons) and bullion (20,000 metric tons). In other words, most of the world's gold is in private hands. The amount of gold that is mined per year is comparatively stable at just above 2% of the world's above ground gold (around 2,600 metric tons per year). [All figures in this paragraph were taken from Galmarley.]

What is gold's role today?

Beside its unchanged prominent role for jewellery, gold still has a special position in the financial world of today. Gold is sometimes viewed at as a hedge against general inflation, but in particular also as a hedge against oil price inflation. Furthermore, since its (former) status as world currency, gold can be used as a means of diversification of foreign exchange rate risk. Although the world's central banks nowaday create fiat money, i.e. money that is not backed by gold or any tangibles anymore, many are still quite active in the gold market. Where most European central banks sold gold in recent years, it is known that some Asian banks (e.g. the Russian central bank) have purchased larger quantities. This could be seen as a sign of the need for alternative reserve methods in the face of a weakening US-Dollar.

How is gold doing financially?

Since its maximum price of more than USD 800 (in fact, almost USD 900) per ounce in the early 1980's, the price of gold was almost continuously decaying till the end of the 1990's. However, many people think that gold is in a bull market since 2001, with the USD-price having doubled since then. Some spectators think that gold might see a great renaissance in the face of severe economic, financial and social problems of the industrialized countries. These problems are usually named as the debt-stricken American and European state finances, overvalued currencies (USD, GBP), property price bubbles in the US and the UK (along with debt-driven consumption), the ongoing crisis in the Middle East (and implications for the oil price), increasing interest rates in Japan and the implications for hedge-funds that practice Yen-carry-trade, unfavourable demographic developments. It is believed that these problems might have a severe impact on the US- and the world economy on a relatively short time horizon.

Is the financial importance of gold controversial?

Yes, it definitely is. Since the gold standard of the US-Dollar was abolished in 1971, the world relies on fiat money. Some people believe that gold today is just another rare metal, a commodity like many others. People who think so might still acknowledge that gold has been undervalued during the 1990's and could have a considerable financial potential in the near future. However, there is also a fraction of people who believe that the higher recent levels of the gold price are due to a general boom in commodities, which might be over soon with gold prices falling to lower levels again. Others believe that gold has never completely lost its role as a world currency. In the face of several hyperinflationary monetary catastrophies during the last century, these people believe that gold is the ultimate inflation hedge and will gain immensely in value when the above mentioned financial inequilibria unravel, and speculators, private investors and financial institutions will start buying gold as a financial safe haven (see e.g. Paul van Eeden's weekly commentary). There are also people who believe that there is collusion among financial institutions to manipulate the gold price (see GATA).

How to invest in gold?

There are many ways to invest in gold as private investor. People interested in owning physical gold usually buy bullion (coins or bars). For instance, in the UK and in Germany, such purchases are VAT-exempt, whereas silver purchases are not. It is also possible to invest money in gold funds or gold-related options. If an investor is interested in gold itself (and not in related or derived products), some important topics should be carefully considered. Firstly, buying real bullion (with delivery at home) usually comes along with a comparatively hefty premium over the gold price. For small amounts (up to a couple of ounces), premiums of 5%-7% are normal. Secondly, unsecured and un-insured storage at home might be another problem with this kind of investment. If a bullion bar is delivered to a private investor (e.g. to his/her home or even to his/her bank safe), the bullion leaves the so-called chain of integrity of the gold trading community. Put simple, after being removed from acknowledged vaults, gold has always to be examined when sold again to make sure it is of the quality and quantity the seller claims. This can be expensive. For larger quantities it is therefore inevitable to find other means of purchasing and storing. If gold is bought via a bank (and is stored with that bank), the problem coming along is often that the bought gold is 'unallocated'. This however means that in the case of a bankruptcy of the respective bank the gold might be repossessed by creditors of the bank. Therefore, private investor should make sure that they own allocated gold. Fortunately, in recent years, a few businesses have started to provide excellent services where allocated gold can be bought, securely stored and also be traded for very competitive fees. There are also metal-backed electronic currencies that could be interesting for people who want to buy and sell online using precious metals. Some links:
A beginner's guide to investing in gold on the MoneyWeek webpages
Gold as an investment from Wikipedia
BullionVault, a business that enables private investors to buy, store and trade gold in vaults in London, New York and Zurich
Chard's, buy and sell VAT-free gold bullion
e-gold, an electronic gold-backed currency


Disclaimer: These webpages reflect the personal views and opinions of some people working for Approximity. They are not intended to be investment advice or financial advice to any person or institution. While provided information is believed to be correct, correctness cannot be guaranteed. Furthermore, information might be subject to change without notice or become outdated. Approximity does not accept any responsibility for any (direct or indirect) investment decisions arising from the use of the information on these webpages. The responsibility for contents and information on external webpages lies completely with the respective authors. External links might be subject to changes or outdating without notice on Approximity's webpages.

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Last update: February 01, 2008 (Approximity)