May 02, 2016
Is Gold a Store of Value?
Is Gold a Store of Value?
The U.S. dollar used to be backed by gold. Anyone could exchange their paper currency for a certain amount of gold (e.g. $35 per ounce). That changed on August 15, 1971 when President Nixon ended convertibility by "closing the gold window".
Since 1971, the U.S. dollar has not been backed by gold and it has fallen to less than 17 cents in 1971 dollar terms. One dollar today will buy only 17 cents worth of "stuff" versus one dollar worth of "stuff" that a dollar would buy you 45 years ago. The dollar has declined in value by 83% due to inflation.
The average price of an ounce of gold in 1971 was US$40.62. Today, gold trades at about US$1255. It reached a high of US$1921.50 in September 2011, but has since pulled back. In 1971 dollar terms, the price of gold today would be about US$212. So, in equivalent terms, an ounce of gold that would have bought you $40.62 worth of "stuff" in 1971 will buy you US$212 worth of "stuff" today. That is 422% more.
So, does gold hold its value over time? That appears to be true, even though gold is a commodity and can, therefore, experience a lot of price volatility over the short term.
The knock on gold as an investment always has been that it pays you no interest. There is even a small fee to own and store physical gold. But gold – being very liquid – should be seen as a cash substitute and these days there is no income on cash either. In fact, there are countries where banks charge a negative rate of interest on deposits so that it actually costs money to hold cash. In an environment with negative interest rates, gold becomes a very attractive alternative to cash.
Further, it is possible to generate income from gold positions in a portfolio by writing options or by owning shares in gold and silver producers and royalty companies that pay dividends.
The takeaway is that inflation erodes the value of paper currencies over time, and gold investments can preserve wealth by providing some insurance against the ravages of inflation in a diversified portfolio.
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