Gold is traditionally sought after as a store of value in times of severe economic dislocation, an insurance policy against financial Armageddon. Most notably, gold has in the past proven a useful hedge against inflation.
Its value as an inflation hedge and its low- to negative- correlations with most broad asset classes can make gold a worthwhile investment for a small portion of an investor’s portfolio. As for an investment in physical gold through an exchange traded product (ETP), we think that gold ETPs are easily some of the least costly and most liquid ways to achieve one’s gilded aspirations that exist.
How Can One Value Something That's Worth Nothing?
Gold has no intrinsic value. The yellow metal does not produce earnings or cash flows that it can share with investors, like equities. Nor does it throw off fixed or floating coupon payments, as a bond does. Financial theory tells us that a security’s intrinsic worth is equivalent to the present value of the future cash flows it will generate. With no cash flows to project and discount back to today, at the end of the day gold is a purely speculative instrument: it is only worth what someone else is willing to pay for it.
The speculative nature of an investment in gold doesn’t differentiate it from other commodities like oil or wheat, which, like gold, have no intrinsic worth. What makes gold different from most commodities is that it has little practical use. Gold cannot fuel a car or provide nourishment.
According to the World Gold Council, only around 10% of current gold demand comes in the form of practical uses – such as in dentistry and electronics. The majority of gold demand around 49% comes from the jewellery industry, with India and China being the most notable drivers of incremental consumption in recent years.
Meanwhile, the remainder of the global appetite for the yellow metal comes from investors. Investment demand for gold has surged in recent years as concerns over paper currencies have flared and the world’s most precious metal has been made increasingly accessible to the masses, thanks to a handful of industrious ETP providers.
Gold is now more accessible than ever – when else in history has gold been sold from vending machines?
Whether the price of gold will soon tumble or spiral higher is nearly impossible to tell. What we can say for certain is that the ETPs backed by physical gold are an excellent way to gain exposure to the yellow metal for investors and speculators alike.
The Golden Benchmark
The vast majority of bullion-tracking ETP assets can be found in products that invest directly in physical gold, and will track movements in the spot price of the yellow metal, minus fees. Most are benchmarked to the pm London Gold Fixing.
The London Gold Fixing takes place twice each business day at 10:30am and 3pm. The fixing process determines the settlement price for contracts arranged amongst the members of the London Bullion Market. This price – which is expressed in terms of US dollars per troy ounce – is in turn used as a benchmark for the vast majority of the gold products and gold-related derivatives around the globe.
A version of this article was originally published September 2010
