Gold: A Perpetual Store Of Value
The price of gold has powerful impacts on our economies
Since the dawn of humanity, gold has been considered a valuable and precious material but it is not until 643 B.C. and the Lydian minting of gold coins that we first start to see gold being used as a store of monetary value. In ancient times coins would have holes in the center and could be strung on cords. However, carrying precious metal around presented issues for convenience and security.
“The desire of gold is not for gold. It is for the means of freedom and benefit.” — Ralph Emerson
The Roman emperor Augustus who reigned from 30 B.C. until 14 A.D set the price of gold at 45 coins to a pound of gold. Later, Marcus Aurelius Antoninus (211 and 217 A.D.) inflated gold’s value to 50 coins per pound. This had the impact of reducing the value of the coins while increasing the value of gold. The debasing of the gold currency happened again under Diocletian who raised the number of gold coins to the pound from 50 to 60. Finally, it was Constantine the Great, who pushed the value to 70 coins per pound during the years 306 A.D. to 337 A.D. These inflationary policies were used to raise finance for conflict and the adverse economic impact on society was compounded by rising taxes.
The result of successive reductions in the value of gold coins lead to a state of hyperinflation. It is estimated that during this period the price of one pound of gold went from 50,000 denarii in 301 A.D. to 20 million denarii by 337 A.D. This is an incredible rate of inflation during one lifetime.
The British were more cautious in their approach to gold valuation and in 1257 Great Britain set the price for an ounce of gold at 0.89 pounds. The price of gold set by the British was to rise by approximately 1 pound over each successive century.
By the time paper money was in broad circulation during the 1800s other countries were operating versions of what was known as the gold standard. This allowed them to peg the value of their paper currency to a specific weight of physical gold. To maintain the gold standard countries were required to retain enough gold reserves to meet the obligations of their paper currency. Later the Gold Standard Act in the United States was to set the value of gold at $20.67 per ounce.
Before The United States implemented the Gold Standard Act, they used the British gold standard. This set the price of gold at $19.49 per ounce in 1791 but was later raised in 1834 to $20.69 per ounce. The British managed to keep the value of gold at 4.25 pounds per ounce until the enactment of the infamous Bretton Woods Agreement in 1944. This was a turning point in the global price of gold as global currencies began pegging themselves to the dollar instead of gold as The United States owned what was supposedly the world’s largest stockpile of gold.
It is widely recognized that the Gold Standard Act and the raising of rates by the Federal Reserve were two key factors that contributed to both the lengthening and deepening impact of the Great Depression. The great stock market crash of 1929 saw the contracting of the United States economy in just five years and prompted many people to rush to the banks to redeem their paper money for physical gold. By 1933 the United States was so concerned about their diminishing stockpile of gold that in 1934 Congress passed the Gold Reserve Act which prohibited any private ownership of gold. It is interesting that there were a few exemptions to this rule as some people were given special dispensations to legally own gold. It would be fascinating to discover who those exemptions were granted to.
In 1971 President Nixon declared that the Federal Reserve would stop honoring dollars in physical gold and decoupled the dollar from the gold standard. Since that point the United States dollar has not been backed by any physical commodity and some commentators believe that the United States dollar is today worth only a fraction of its perceived value.
Once gold was disengaged from the United States dollar its price exploded on the open market rising to $120 an ounce. During the 1980s traders wishing to hedge against the rampant inflation of the period were investing heavily in gold which pushed its price to $594.92. Gold’s price then eroded to $410 an ounce and was relatively stable until 1996 when it fell further to $288 per ounce.
Just over a decade later during the financial crisis of 2008 investors that were looking to hedge against the impact of an economic slowdown helped push the price of gold up to $869.75. Three years later in 2011, the price of gold reached its all-time peak of $1,895 as a response to investor concerns that the United States would be unable to service its debt.
Since 2011, the price of gold has fallen as the United States economy has improved and the inflation rate has been relatively stable. Gold’s current price hovers around $1,500 and until very recently the market for the precious metal has been comparably stagnant.
Globally gold is valued based upon its spot price, but is gold’s spot price the same everywhere? As gold is globally traded and the denominated volume of gold is identical, theoretically the spot price for gold should be the same wherever you wish to trade. However, because of currency fluctuations there can be marginal differences in the spot price due to the currency conversion. Another factor that impacts the price you can purchase gold for is the varying cost of dealer premiums, so if you are buying gold it is important to research the market for the best price. Although available almost everywhere some of the largest markets for gold trading are in the United States, London, Zurich, China, and India.
If we wish to understand where prices are going it is instructive to look back to where prices have been. The gold market is based on global supply and demand. With the demand for gold rising due to population growth and the supply of gold diminishing and getting harder to extract it is clear that the long-term price of gold will rise as more people bid on less gold in the market. To put things in perspective it has been estimated that only 171,000 metric tons of gold have been mined in all of human history. This may sound like a lot but it is actually a relatively small volume and there have been periods of time in which the volume of gold mined remained relatively static.
The current spot price of gold is not solely based upon investment considerations. The yellow metal is also purchased for jewelry production and industrial applications. Because gold is usually denominated in dollars the value of the dollar can have an impact on the market’s appetite for the precious metal. A rise in the comparative value of the dollar can make gold comparatively more expensive for foreign investors and conversely, a drop in the dollar can make gold attractive for investors. Another key factor that impacts the price of gold is the rate of interest being offered by the banks. As gold does not deliver any dividends a high rate of interest makes gold less attractive to investors and a low rate of interest improves gold’s price because investors suffer reduced opportunity cost.
Fundamentally it seems that there are discounts available in the gold market and the value of gold only appears to be rising over time. Both of these reasons add up to make gold a solid long-term investment and hedge against inflation and market volatility.