Gold is attracting attention from investors, with prices up from $350 per ounce in May 2003 to more than $650 per ounce in early 2007. As prices rise, more and more investors are wondering how, if and when to jump in. Global trends appear favorable for gold, but too much attention could be problematic.
Rising demand
Gold is especially attractive in times of economic and political crisis. As the most widely accepted global currency, gold is viewed as a source of stability in times of currency inflation, stock market uncertainty and political conflict.
International demand for gold has also increased in recent years and shows no signs of slowing. Many emerging economies are seeking gold to build up their currency reserves. China, India and Russia are seeking gold as a reserve and also for individual collections in the form of jewelry and gifts.
Demand for gold in the Middle East has increased in response to recent political conflicts with and alienation from the U.S. Many investors are diversifying assets out of dollars and into gold and alternate currencies, such as the Euro. Some countries are losing faith in the U.S. dollar and seeking protection through diversification.
In the past, major trading nations attempted to ensure the soundness of their currencies by adhering to a “gold standard.” This meant that a dollar, for example, was equal to and could be exchanged for a specific weight in gold.
In 1973, the U.S. officially ended its adherence to a gold exchange standard, according to the Federal Reserve’s website. At that time, the U.S. and many other nations shifted to “fiat” currency systems where currency is created by a government and accepted on trust rather than backing in hard assets.
The danger with fiat currency is that nations may lose discretion and print too much currency or allow too much credit, devaluing the currency and causing inflation. Gold serves as a bulwark against a dropping dollar and other fiat currencies in part because it can’t be produced at will.
Even as global demand has increased, gold mining efforts have actually decreased production because of a decreasing supply of easily accessible reserves. Limitations in the global supply of gold ensure its precious nature.
Volatility
Gold is a volatile investment—three times more so than the stock market, according to CNNMoney’s Walter Updegrave. A limited and relatively small global supply and small market share mean that small changes can have a big impact on gold prices. One big seller getting out of the gold market can flood the market with gold; likewise, increased demand can easily drive up prices. The emotional aspect of many gold investments add to its volatility.
Although gold is a risky investment on its own, it can be useful as part of an overall portfolio. Gold prices have the advantage of independence from correlation with stock market prices, and gold investments can he...
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