Common Myths About Gold

Gold is a luxurious, rare and appealing material. We wear it on our body as jewellry and use it in electronics and other industrial products to build technology. In the modern financial media, much time is spent discussing the gold price, and bearish apocalyptic investors hold ounces of the stuff to ‘protect their wealth against the government’. Yet despite the importance of gold in our society, there are many pervasie myths about gold.

Gold Myth #1 – It is Illegal to Own Gold

This myth is held in several different countries, and is based in truth. Gold was outlawed in the US in 1933, and this gold prohibition was not lifted until as late at 1974 when President Gerald Ford signed legislation that permitted Americans again to own gold bullion, coin, or certificates representing ownership worth over $100. This happened just after the great depression, when the public began hoarding gold, which undermined the federal reserves plans to begin increasing the money supply in a Keynesian attempt to stimulate the economy.

Since the 1974 Act, there are no restrictions on US individuals buying gold coins, gold bullion bars and gold certificates. Indeed, the US Mint now even sells gold coins to the public.

Gold Myth #2 – Gold is a Perfect Hedge Against Inflation

The principal purpose of holding gold as an investment is to hedge against inflation. It is important to note however that gold is not an ideal hedging instrument, and MANY better inflation hedges exist. In the UK, citizens can purchase index-linked certificates from National Savings & Investments, which is backed by HM Treasury. These certificates promise to pay a return of the monthly RPI plus a nominal interest rate per year (currently 0.5%). As the returns are also tax-free, these are clearly effective hedges. Gold on the other hand is a volatile investment that may reduce in value during a year where inflation increases. Inflation and gold prices have a distinct correlation – but the actual gold price deviates about this trend in such a violent manner that it cannot be said to be an effective hedge.

To demonstrate this failure in another way, lets look at how accounting regulators view hedging. Specialist accounting treatment (called Hedge Accounting) is allowed by companies who use effective hedging instruments (for instance, to offset gains and losses on foreign currency loans and assets.). The effect of this special treatment is that these companies are allowed to post the gain/loss from the hedging instrument, to the same area of the Profit & Loss account as the opposite gain/loss from the hedged item. This should result in a visible net effect of nil. My point is that if a company used gold as a hedge against inflation risk, under the current rules, this would not be viewed as effective enough to qualify for Hedge Accounting. It would instead be reported as a speculative gain or loss. If holding gold isn’t precise and effective enough to qualify for hedge accounting, it certainly won’t be a precise and effective hedge in your portfolio.

Gold Myth #3 – Gold is a Safe Investment.

I directly refer to this myth in my article ‘10 Shocking Mistakes Most New Investors Make‘. It stems from the reference to gold in the financial press as a ‘safe haven’. Inexperienced investors tend to equate ‘safe haven’ and ‘safe investment’ as the same thing. The problem is that while ‘safe investment’ implies capital protection and low volatility, gold is anything but this. Take a look at this graph of gold prices from Kitco.com.

As you can see from the graph, golds history has been blighted with price crashes and spikes. A particularly dreary piece of analysis is that if you had invested in gold in 1980, the gold price wouldn’t have recovered to its nominal spike of $750 per oz until 2006. This still doesn’t tell the whole story though, as $850 dollars in 1980 is equivilant to $2251 in todays prices. In other words, gold is still far from recovering to its highest peak. As well as disproving the above myth about gold protecting against inflation, one can also intrepret this to mean that gold is a very risky investment. Consequently it should only be undertaken by experienced investors who understand the behaviour and risks of investing in gold. For an inflation-adjusted graph of the price of gold, click here.

Gold Myth #4 – Gold is Difficult to Invest in

The traditional view of gold investment is the iconic notion of storing a small collection of gold coins and bars in your basement. In actuality, gold investment has always been easier, simpler and cheaper than this. Gold certificates have been issued by banks for hundreds of years, and were the original currency of industrial nations that had adopted the gold standard. Still today, gold certificates, which entitles you to a specific quantity of gold supposedly held by a bank deep inside its vaults.

As I explain in the Financial Expert guide on ‘How to Invest in Commodities‘, investors can gain exposure to the gold price through physical gold ETFs and synthetic gold ETFs, which I explain in more detail in dedicated articles. ETFs can be bought simply through a broker as if it were a stock or share. Investments dont get simpler than that!

 

Simon OatesCommon Myths About Gold