Since gold has been skyrocketing for a while, there is hardly any day where financial columnists ignore the topic. Warren Buffet does not like gold, he thinks it is an unproductive asset, not yielding any interest or dividends. That is of course true and if you want to support overall economic growth, you should not withdraw your wealth from the economy and store it in unproductive gold. If you happen to be as rich as Mr. Buffet your individual actions might indeed make a difference, but most of us are more concerned to preserve or increase our personal wealth.
There are three main sectors creating demand for gold: investment, jewelry, and industry. The latter two are to a certain extent predictable. Gold is more or less a normal commodity like any other. If prices go up, demand will decrease. The interesting part is gold as an investment tool. So why are people investing in gold after all? Mostly because they believe that it will preserve its value during difficult times. The trust in gold as a crisis hedge has historic reasons and not too long ago paper money had to be backed by gold reserves (the so called gold standard). Whether gold lives up to its promise, taken the other two demand sources aside, is pure market psychology. If people stop believing that gold has any lasting value, its price will collapse. With the same justification, investors could decide that diamonds will preserve wealth better and start investing in it at a grand scale. Having said that, it should to be made clear that a complete shift of investors’ perception of gold is highly unlikely at this point.
Why are gold prices going through the roof right now? The story with people needing to believe in the value of their investment can be applied to another (un)common investment: money. If people do not believe in the value of money anymore, it will not be worth anything. Hyperinflation and currency reforms are historical facts and investors know that all too well. However, there is one big difference between gold and money. Gold is scarce. Its circulating amount cannot be arbitrarily increased.
As long as central banks and politicians are gradually undermining people’s trust in the value of paper money, they will keep looking for alternatives. Quantitative easing (a euphemism for printing money) and state households increasingly getting out of control will only further nourish that sentiment. With central banks shifting to the buyer’s side and investors just starting to re-discover gold as an investment tool, the prospects for the yellow metal could remain bullish for years to come. Unless investors stop believing in it….
