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Liquidity refers to how easy it is to invest in an asset. Real estate, certificates of deposits, stocks, and index funds are the most common assets investors look into. Why is gold, which is perhaps one of the most liquid assets out there, not on this list?
Unfortunately, investing in gold has some downsides. For starters, gold is not disposable, so the amount of gold around the world will only keep piling up. Moreover, once sold, gold cannot be repurchased, hence why not many investors consider this asset, so why invest in gold?
Contrary to common belief, investing in gold has many perks, and it’s not just a matter of being profitable. You’ll get to know more of that in this article, but before anything else, it might be best to determine the driving factors of gold price and how it can affect your profitability.
What Drives Gold Price?
When an asset is driven by investment demand, its price will only increase if the number of investors is low. When an asset is driven by supply, you will only see an increase in price if the supply is diminishing.
By that logic, if many factors drive an asset, you will often see a price change, whether it’s an increase or a decrease. Gold happens to be driven by many factors, such as:
- Investor Behavior
- Supply and Demand
- Monetary Policies
If there’s a significant change within any of these factors, the price of gold will also change. That’s why when you start investing, you need to consider several factors, and that’s why you’re here. This article will look at each of these factors and their advantages to investors such as yourself.
Gold Is Increasing In Value
As mentioned earlier, investor behavior is one of the deciding factors of gold price. This refers to the number of people investing in an asset and how much they’re investing.
If a lot of people invest in an asset, naturally, its price will increase. The same goes for when a massive amount of investments are made in a particular asset. Fortunately, the yellow metal is attracting more and more investors since its introduction to this industry.
Because of this, its price is increasing drastically over the years, making it a great reason to consider gold as an investment. To illustrate further, here’s a look at the price of gold in three different years:
- February 1915: February 1915 is the starting point of gold as a liquid asset, and its price at that time was only around $500 an ounce.
- September 1970: The lowest price of gold was around $240. A recession brought this sharp price decrease at that time, where gold wasn’t as attractive to investors.
- August 2020: At this point, an ounce of gold will cost you around $2,000, when only just a year ago, the price was about $1200. This alarming increase is mainly due to the Covid-19 pandemic that brought upon a global economic crisis.
As you can see, during the Great Depression, not many people are investing in gold, which explains its low price. However, during the pandemic, many people clung to this yellow metal, which in turn increased the price of gold significantly.
The bad news is that the global economy is slowly regaining its stability. For that reason, numerous investors think that it might be time to consider withdrawing their investments since the price of gold may lose its momentum in the coming years, but that’s not entirely true.
In fact, it’s the complete opposite of what the majority think, as numerous experts suggest that the price of gold is bound to increase starting in 2021, mainly because of the supply.
Supply Of Gold Is Dwindling
One of the obvious reasons to consider gold as an investment is, supply. Supply is another essential factor that drives the price of gold. When it comes to paper money, the more cash is printed, the lower its value will be. However, in the case of gold, technology can’t create it, and it can only come from gold mines. And compared to other metals, gold mines are relatively rare, so the production rate is minimal.
On the other hand, since gold isn’t consumed, it’s only right to believe that gold price should decrease over time, especially since the majority of gold from decades ago is still around to this day. But why does the gold price keep increasing?
To begin with, supply and demand are inversely proportional. More supply means less demand and price. But when an asset is scarce, the demand skyrockets, and so is the price. The most crucial part is that gold production is slowly dwindling over the years.
Thus, experts predict that the price of gold will skyrocket in the future and will serve as an excellent hedge in case of massive inflation.
Gold Is A Great Inflation Hedge
Inflation refers to the rise in the price level of goods and services. For example, last year, the price of bagels might be $1, but next year, it can become $2. This price increase is brought about by a decrease in the number of bagel buyers. Since inflation is inevitable, all you can do is prepare for it, and the best way to do that is by getting an inflation hedge.
Getting an inflation hedge is when you invest in an asset that increases in price when inflation becomes severe. Examples of inflation hedge assets include:
- Real Estate Investment Trusts
- Leveraged Loans
- Real Estate Income
- S&P 500
Among these assets, there is one that can be considered the best inflation hedge, and that would be gold. However, people tend to think that just because gold is an excellent inflation hedge, you can’t use it to protect from deflation, but they’re entirely wrong.
Gold As A Deflation Protection
Reasons to consider gold as an investment, deflation. Deflation is the exact opposite of inflation—it’s where goods and services decrease in price. Some of the most reliable deflation hedges include:
- Dividend-paying stocks
- Investment-grade bonds
- Defensive stocks
If cash loses its value during inflation, the opposite occurs during deflation. For that reason, cash is the best deflation hedge as its value increases significantly.
What’s surprising is that although gold price typically increases during inflation, there are also cases where gold rose in value during deflationary events, such as when the Great Depression occurred in the 1930s.
So, not only is gold a good inflation hedge, but it can also serve as deflation protection. Besides, even if gold doesn’t perform well during deflation, it still serves as a great way to diversify your investment portfolio, which takes us to the next section.
Gold Can Diversify Your Portfolio
For investors, portfolio diversification refers to the process of investing in different assets. They do this to prevent losing money at once in case the asset they invest in drops in price. Simply put, diversification reduces your risks, but at the same time, it divides the potential profits. Basically, it’s a technique to ensure that you’re not putting all your eggs in one basket.
For that reason, every good investor will know how vital portfolio diversification is, which is why even if an asset isn’t particularly profitable, it’s still worth investing just for the sake of portfolio diversification, but what does this have to do with gold?
To begin with, the best way to diversify investments is to invest in an asset that increases in value when the prices of paper investments like bonds and stocks decrease. One asset that fits the bill is none other than gold.
In fact, gold is even more suited for deflation than inflation, mainly because deflationary events often decrease interest rates, or more specifically, monetary policy. One of the best reasons to consider gold as an investment.
Gold Retains Its Value Regardless Of Monetary Policy
Monetary policy is the policy within the economy of a country that deals with the growth rate or interest rates of money. Each country has its own monetary policies.
When the interest rates decrease, the prices of assets also increase. For that reason, investors often look at their countries’ monetary policy when considering what assets to invest in. The good news is that monetary policy is one of the driving factors of gold price.
More particularly, when interest rates decrease, there is a significant increase in the gold price, but the change within the gold price is negligible when the opposite occurs.
In short, the risk-reward ratio of gold when it comes to the monetary policy is very favorable for investors such as yourself. Besides, interest rates are dropping since 2020 and are expected to continue declining in the coming years.
So these are the reasons to consider gold as an investment. As an investor, the idea of investing in gold must have crossed your mind a couple of times. The only difference this time is that you’re now more knowledgeable about this yellow metal.
Although you may have missed out on the massive increase in price brought by the pandemic, there’s still a huge possibility of gold from increasing in the coming of yours, so it’s not too late to invest now.