4 Reasons Why History Chose Gold – and What it Should Tell You as an Investor
These days, discussion about gold is often divided between two camps which, quite loudly, prophesize drastically different market futures. On the one hand, we have those eager to declare the “Era of Gold is Over” after every drop in price; on the other, champions of gold warn of the dollar inflating into obscurity and leaving behind those without the foresight to buy precious metals.
You may believe that too many investors have rushed into gold in the past decade or you may believe that massive amounts of money printed by the Federal Reserve will inevitably lead to a crumbling dollar (or neither); either way, that’s missing the point:
Gold is here to stay. That doesn’t mean it can’t lose some value from time to time (commodities always have and always will). Nevertheless, it was no accident that history chose gold and other precious metals, first as a currency and then as a hedge, for monetary purposes. Gold has intrinsic, fundamental strengths that give it value – fundamentals that don’t rise and fall with the stock market.
In order to explain why gold will always have its place in the market, we break down the most crucial aspects of gold that you won’t hear in modern, emotional debates about the yellow metal. You’ll see why history did not make a mistake with gold.
Gold Has Real Value – It’s Stable
Currently, the United States (like every nation) operates under what is known as a fiat money standard, which means that the currency in use (dollars, yen, euros, etc.) only have value because a central government claims that it has value. Not really backed by anything, these are intrinsically useless pieces of paper or bits of virtual code. Since fiat currency is not useful in any meaningful way, its value can drop to zero if too much of it is circulated. Things get really ugly when this happens. If you don’t believe me, scan this historical recap.
Gold isn’t like that because it is a market-based commodity – meaning that it is a useful good outside of being a financial instrument. Gold is used for the making of valuable jewelry, the manufacturing of electronics like computers or cell phones, in dentistry, in aerospace circuitry and even for some medical purposes. On top of these functional uses, gold has been a status symbol across nearly every civilization that has ever come into contact with it. Gold will never reach zero value (and it has never come close). Here is a great infographic about the uses of gold.
Gold is Durable, Malleable, and Equally Divisible – It Survives
Not just any commodity can be a useful financial instrument the way gold can be. This is one of the primary reasons that gold has held its prominence for millennia. Just imagine if, say, bananas were to be used as money: bananas are soft, perishable and vary from region to region. Bananas can’t hold value. What about diamonds? The same is true for any biologically “living” commodity.
What about diamonds? They are valuable, universally recognized and are physically much tougher than gold. However, what happens when you break a diamond into three pieces? The combined value of those three individual pieces will be less than the original value of the whole even though the total weight didn't change. Diamonds are not equally divisible; gold is. Gold can be melted and reformed, bent and broken, but an ounce of gold is still worth an ounce of gold.
Gold Needs to be Mined – It is Scarce
This might be the most important reason why gold thrives and why fiat currencies die. Nothing is easier to produce than little green slips of paper. Governments and Banks can print and print and print. It is an economic law that goods have value because they are scarce. There is no guarantee that dollars or pounds sterling will remain scarce enough to hold value.
Gold requires labor, equipment, time and locating in order to increase supply. Demand for gold may fluctuate from time to time, but the supply is steady and predictable. Steady and predictable are good for investors. Short of the discovery of alchemy, gold will remain scarce.
Free Markets Chose Gold – It Doesn't Need Government Backing
In the time before printing presses, central banks and nation-states, traders and merchants needed a way to facilitate trade and exchange goods. Throughout history, lots of different commodities were tried as money: rice, salt, fruits, candy, etc. It was precious metals like gold, however, that won the Darwinian competition to serve as financial instruments. Besides the reasons listed above, gold was portable, lightweight, could get wet, can’t be forged, can be easily stacked and stored and was accepted by a variety of cultures. Gold naturally filled that role without a decree from any authority.
These fundamental qualities pre-date and will post-date stock exchanges, fiat currencies, market trends and economic crises. You don’t need FDIC insurance on gold – you can’t have “fractional reserves” of gold in a banking system. Gold survived and held value through world wars, plagues, industrial revolutions, recessions, depressions and even the discovery of virtual currencies.
What History Teaches Investors
What does all of this mean to the investor? As this is written, the price of gold is trading at just over $1,291 per ounce. That’s well below its peak in late 2011, and many, many times what it was worth a decade ago. When gold was originally exposed to market pricing after the abandonment of the Gold Standard, its price climbed 3,689% (from $35 per ounce). In that same time period, the dollar has lost more than 90% of its purchasing power.
Nobody can predict the price of gold 5 years from now or 35 years from now. What history can teach the investor is that gold will always retain value, and that gold has always increased in value over the long-run.
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