Gold is very much in the news these days with prices hitting fresh all-time highs seemingly every day. A recent paper by Dirk Baur of the University of Technology, Sydney, looked for empirical evidence of the factors that explain higher gold prices in data spanning the 1979 to 2010 time period (hat tip to Cameron Passmore of PWL Capital for highlighting this paper in a radio interview).

Highlights from the paper:

– Gold has acted as a hedge against a weaker US dollar and higher commodity prices.

– Gold prices increased when the short-term opportunity cost of holding gold decreased. Prices also increased when investors expected higher long-term inflation.

– Evidence for gold as an inflation hedge is weak.

– Gold acted mainly as a store of value against currency devaluations and commodity price changes until the mid 1990s. Since then, it has assumed an additional role as a safe haven — a hedge against stock market changes.

The paper is available here.

This article has 13 comments

  1. I think gold also goes through phases when it goes up simply because of speculation — people want to buy because they think they can sell to another fool at a greater price.

  2. Being an engineer by profession, I view gold as an engineering material whose cost is too prohibitive for most practicable purposes. Industrially, it is mostly used for electroplating in electronics or some aerospace applications where any degree of corrosion cannot be tolerated.

    Of course, if you call it an “industry”, jewelers use it to make shiny baubles – which is the premier use for the past couple thousand years or so. ;0)

  3. I think that gold is simply another form of money, and it’s not more complicated than that. I agree with Warren Buffett that it’s not an investment in the traditional sense — it doesn’t produce dividends and it doesn’t do any work. What it DOES do, however, is provide a form of money that cannot be debased nor politically manipulated as easily as paper money can. If all of the paper money systems collapsed, gold would still be there. That is where gold’s true value lies — as a free market currency, independent of any political regime.

  4. P.S. I agree with Larry. High prices are starting to attract a lot of people looking to “flip”, and although I stand by my view on gold, it is vulnerable to an asset bubble just like any other asset. So long as the fundamentals attracting people to gold remain strong (QE, uncertainty in US policy, etc…) then I don’t think prices would completely collapse, but it’s still possible to buy in at too high of a price.

  5. Kudos to CC for generating a useful discussion on an asset class that he doesn’t really endorse, because it is not really a “buy and hold forever” asset.

    Having 5 or 10% of a balanced portfolio in a gold or precious metals fund or ETF can be profitable and prudent in times of: economic uncertainty; likely US currency debasement; and possible inflation or deflation.

    Good work CC.

  6. @Larry: There is a large element of performance chasing in Gold. Investment interest is exploding at the same time that jewellery demand is falling and scrap metal supply is increasing. I think the main reason is the ease with which investors can buy gold these days in their brokerage accounts.

    @Phil: You are right about jewellery being the largest user of gold. The GLD prospectus has interesting information on gold supply and demand. Jewellery demand for gold in 2009 was 1,700 tonnes compared to 246 tonnes in electronics.

    @Invest It Wisely: Gold may or may not be free of political manipulation but it is definitely at the mercy of market forces. Fully 40% of the total demand for gold today comes from investors. That’s up from 16% in 2005. It seems pretty clear to me that investors are chasing gold. If the past is any indication, this too will end badly eventually.

    @Dr. Dale: I listened to Mr. Passmore’s interview the other day and thought that with gold being top of mind of many investors these days, a rigorous look into what affects gold prices would interest readers.

    I have zero allocation to gold bullion. With broad-market ETFs, Canadian investors already have about 20% of their Canadian equity allocation in gold equities.

  7. @CC good point! and good work!

  8. I reject the view that gold is a currency. When people go away on vacation or on business, they don’t carry gold coins or bars in their pockets. We use government issued currencies, traveler’s cheques or in this day and age, plastic credit cards. You can’t go to a store and spend gold coins and hope to get gold coins in smaller denominations in change.

    Not only that, different issuers have different purities. In fact, I think our Canadian Maple Leaf gold coins are the purest in the world. But are they worth any more than the less pure American Eagle coins or the more common South African Krugerrands? There simply is no standard.

    I lump gold coins into the same bucket as jewelry. But instead of wearing it as rings and necklaces, coin collectors put them into their collections in display cases, collecting a series or a variety of countries of origin in appreciation of the artwork that goes into the faces of the coins.

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  13. “You have to choose between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold.”
    -George Bernard Shaw