Investing in gold is riskier than is believed

By Time of article published Jan 19, 2012

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We enter 2012 with even more uncertainty than we left 2011 and the reaction of the market is evident. Everyone is screaming “gold” with many predicting that it will peak at more than $2 000 (R16 010) an ounce before year-end. But why?

To answer this we need to look at where investors and private individuals store their excess wealth. All investors want to keep their wealth in a place where it will grow, or at the very least, keep its value. But such places are hard to find in times of recession.

Most commonly, wealth is stored in property, shares, money or forms of it, or high-value commodities such as gold and platinum. Having reached the peak of its boom late in the past decade the property market has all but stagnated. And with incomes remaining low and jobs scarce it is unlikely to stage a rebound any time soon. Company share ownership, or forms thereof, is a risky option as business still treads murky waters the world over.

But perhaps the biggest loss of value caused by 2011 will show in money itself. In an effort to prevent the western economy from complete collapse, complex bailout plans and stimulus schemes have been devised, which at their core amount to governments creating more money, such that demand will be stimulated in the short run. But the problem with creating more money is that when there is more of something it is worth less. Through a variety of channels this simply leads to inflation.

Anyone whose wealth is stored or earned in a manner not linked to price changes will therefore see the value of their wealth erode. This includes bondholders, pensioners and those who store their money in a simple transactions account or hold it as cash.

So the race is on to find a haven where the value of wealth will not be eroded by global economic turmoil, and many believe that this lies with gold.

The claim is that because of its old value spanning centuries and the inability of central banks to create it at will, the value of gold will outlast other forms of investment. The evidence only helps to support this sentiment as in the past five years the price of gold has skyrocketed from $600 an ounce to more than $1 600.

But if we go back a few more centuries, we find that gold to the Incas was about as valuable as Tupperware is today, and in the East, hoarding spices would far better guarantee your riches.

Is gold, therefore, not just another good whose value is entirely based on speculation? Has its monetary value and perception of value not completely surpassed its intrinsic value to society?

It is not of crucial significance to society’s survival or progress and therefore its value is not absolute but rather a product of the current trading system.

And what will happen when markets recover and investors shift their wealth back towards higher-risk and higher-gain investments? Huge amounts of gold will be sold, prices will plummet, and any late starter will be scrambling to try and salvage their value while the bubble implodes.

If you are looking to bet on the gold market and are trying to be one of the smart ones who rides the upsurge only to sell out just before the collapse, there is a lot of money to be made if you get it right. But do not be led to believe that gold is safe. Anything whose value is based on human perception rather than human need will only be as secure as human sentiment itself.

Pierre Heistein is the convener of the University of Cape Town’s applied economics for smart decision-making course. Visit [email protected]

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