Is there a best way to buy gold? The answer to this question is one which every serious investor interested in gold must grapple.
Although we obviously can’t make this decision for you, we’ve created this guide on the benefits of investing in a precious metal in order to help you consider this option for yourself.
In this guide, we will be primarily focusing on the benefits of investing in gold as a commodity in general; for the reasons on why you should choose the gold IRA account over other methods of investing in gold (such as Exchange Traded Funds), kindly refer to our other guides available on this site.
There are 3 main reasons that a savvy investor would want to invest in gold, namely:
- Gold is a safe haven investment
- Gold is a powerful mechanism for portfolio diversification
- Gold has demonstrated good long-term historical returns
Let us now take a look at each of the 3 reasons in detail.
Gold is a Safe-Haven Investment
Gold has a long history of being used a store of value in turbulent times. For context, the first coins containing gold date back to 800BC and the first pure gold coins were struck around 500BC! Back then, gold was currency and eventually even when paper currency was introduced, the value was always backed by gold, known as the ‘gold standard’.
The US dollar was itself a gold standard currency up to 1933, when it was effectively abandoned in order to stimulate the economy during the Great Depression (the link between the dollar and gold was completely severed in 1971). Currently the US dollar operates under what is known as a fiat money system, meaning the value of the currency is not linked to any specific asset.
Why is this significant?
Simple, in a fiat money system such as ours, the Federal Reserve can simply increase the money supply meet its needs (such as to pay off US government debt, which as of 09/01/16, stands at $19.5 trillion dollars). As the basic law of supply and demand goes, when the supply increases, price goes down. Hence, an increase in the money supply generally results in a decrease in the value of the US dollar and inflation, while decreasing interest rates. The chart below shows the increase in the money supply in the United States from 1959 – 2016.
If we break down the chart to only the past 10 years, the increase looks even more drastic:
On the other hand, according to the World Gold Council, the annual total supply of gold has averaged around 4,000 tonnes over the last 10 years while total above ground inventory has been estimated at 184,000 tonnes. This means that every year, total above ground inventory of gold only increases at a rate of less than 2.5% annually, far lower than the average money supply increase of approximately 6.2%.
Hence, the significance is clear: in an age where the money supply is constantly increasing, with potential negative consequences for the economy as a whole, gold, by being a rare physical commodity is able to hold its value in a way that fiat money cannot match. And while it is true that the US Dollar has been on a strengthening trend recently; that has not always been the case: the chart below is the DXY Index, which measures the strength of the US Dollar against a basket of other currencies, as you can see, the dollar was previously much stronger.
To conclude, it is possible for a stock to go to zero, for a bond to default, for a currency to lose its value. But gold will never be worth zero.
Gold is a Powerful Mechanism for Portfolio Diversification
What is the main theory behind portfolio diversification? Briefly put, the concept is to create a portfolio comprised of multiple investments in order to reduce the overall portfolio risk. This is done by ensuring a portfolio’s investments are not closely correlated with each other. Gold has historically had a negative correlation with stocks and other paper financial instruments such as bonds. This means that gold is an excellent addition to diversify your portfolio and reduce its overall risk. For more on the theory of diversification, this article is a good resource.
The two graphs below show the correlation between gold and the S&P 500 and between gold and US 10-year Treasury yields (i.e. practically risk-free bonds).
As you can see, the correlation is often negative (particularly during recessions), and even when positive, typically remains below the 40% mark.
In addition, geopolitical risk also remains a constant risk factor, even in today’s relatively peaceful times. As we have seen, wars happen and governments do get overthrown. During such times, not only would the citizen of the affected countries’ best investment choice be gold, but the value of gold also tends to increase, to the benefit of gold investors worldwide.
Gold has Demonstrated Good Long-Term Historical Returns
With all the above points about gold being a safe haven, a store of value, and a powerful portfolio diversification mechanism, one may then conclude that it would follow that returns on gold investments would be low in comparison. But, what does the data show?
In the table below, you will see a summary of 10-year historical returns for a common investment option available to government employees: the Thrift Savings Plan. The first five data columns show the historical returns for each of the five funds available under the program. The final column shows the historical returns on gold prices (note that this does not include any taxes payable upon realizing or liquidating your investment, as well as any broker or custodian fees. See our Gold Guide for an explanation of these concepts).
Yes, it is true that since gold price peaked in 2011, the price has been on a generally downward trend. However, gold is an investment for the long-term. And the long term returns comparison shows that the returns on gold outpaced the returns on the TSP G, F, and I funds, with the former two funds being the lowest risk TSP funds.
This means that gold, over the long-term, outperformed 60% of the funds while still being an effective hedge against negative price movements in the other funds!
Is gold the best investment for fast returns?
It’s clear from the data in this article that investing in gold as a speculative short-term bet isn’t the way to go. However, the benefits of investing in gold are clear. Gold is a safe haven investment as it will always be an effective store of value, even in highly uncertain times. Adding a gold investment into your portfolio is also a powerful diversification mechanism that can lower your overall portfolio risk and, over the long term, gold’s returns have been shown to exceed that of some other popular investment alternatives.
We hope that you have taken away something of value from this guide. Choosing the right investment for you can be a daunting task, and hopefully this guide has helped you in giving you the necessary knowledge in making that choice. Thank you for reading. See our Gold IRA Rollover page.