No other asset holds the same magical allure as gold. The yellow metal is seen as the ultimate in last resort insurance, the go- to guy in times of financial uncertainty, the saviour of the investor bedevilled by fears of inflation. Yet what makes gold valuable is no different to what gave the Zimbabwean dollar value in the years before hyperinflation; confidence.
Gold, unlike many other financial assets does not provide a yield. The only return available from holding gold is that in the future someone else is willing to purchase gold from you at a higher price than you paid for it. There can be no change in the ‘fundamental value’ of gold. You cannot build a model that says: the fundamental price of gold is X. You cannot take the view (like you could with other commodities) that demand for the use of gold will be higher in the future that is today, or that the supply of gold is likely to diminish. All you can do is take a view on an expectation that the price of gold in the future will be higher than it is today.
Gold is a bet on the possibility that fiat currency will lose its ability to continue to fulfil the functions of money. Gold has a number of characteristics that enhance its attractiveness as an agent for making this bet. Firstly, Gold is scarce. It is unlikely that in the future discoveries of copious new reserves are going to flood the world with abundant quantities of the precious metal. Secondly, historically, before the invention of fiat currency, people used gold as money, so if fiat currency failed, it seems an obvious candidate to replace it. Thirdly, related to these two prior beliefs, an investment in Gold relies on the belief that it will hold its value relative to other real goods and services (or hold its value better than alternative assets). Above all, your investment in gold relies on a confidence that the rest of the market will continue to see gold in the same way. If fears over the continued of scarcity of gold led investors to turn to say platinum as the new reserve asset, the price of gold may drop precipitously and your confidence in gold may have been misplaced.
This is not to say gold is a poor investment, or that I expect it to relinquish its place at the zenith of every doomsday merchant’s favourite asset. Just that in my opinion gold does not deserve the semi-religious fervour it seems to hold for many of its investors. Gold is susceptible to the same dangers, the same bubbles, the same black swans as any other asset class.