Golden Risks

Although gold investments can be regarded as one of the most tempting venues for investors to venture into with an aim to bump up their investment returns with a commodity that is largely considered safe, it is not exactly as solid and sure as most people think it is.

As a matter of fact, gold should not be even be considered as an investment, it is a hedge, and as a hedge it will always remain and the same goes to silver, platinum or even palladium. It is a hedge that provides a little relief against the risk of losses suffered from other asset classes which includes property, equities and bonds. Gold and other precious metals have always been utilised as a hedge against the pressures of inflation and that same thinking holds until today, despite markets being totally unpredictable and even senseless at times. Basically, owning gold, gives back people who own gold the purchasing power that they lose because of inflation and the truth is that in economics, inflation is a constant as money will continue to depreciate as more and more o it is printed.

The reason for this fear is largely due to the fiscal and monetary policies being executed by the federal reserve due to high federal deficits spending coupled with interest rates kept near zero value, which actually makes gold attractive as most other investments do not have the ability to keep up with inflation.

The simple equation behind this reasoning is when governments offer real interest rates that are negative, that will be exactly what investors will be earning based on those rates and if we were to remove the CPI numbers we end up with a deficit spending minus fiscal slashing causing gold’s value to increase based on that country’s currency. The reverse applies if at all the interest rates were set to 2 percent higher, because if that was affected, the inflation rate it would advocate a decrease in prices of gold.

However, these are just theoretically correct and although they seem to hold true in most instances, there are times when they just do not work as they are supposed to. Sometimes the increase in gold prices are driven by fear and would have nothing to do with interest rates, when the majority of people start having doubts about the direction of the financial system, they abandon most other commodities in favour of gold and the same can be said to happen when there are regional armed conflicts or even terrorist attacks.

Other factors that drive gold prices is demand and a lot depends on the economic conditions in China and India, who just happen to be the world’s biggest gold consumers. Any changes in demand from these two economies have a significant impact on the prices of gold. However, these demand pressures typically attract new supply and therefore even when demand is high, prices have the potential to go down due to new entrants into the market on the supply side.

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