Everybody loves gold; be it in teeth or pension funds, but what investment purpose can be served by an asset that derives most of its value from being shiny?
Part of gold’s appeal is its safe-haven status; indeed it is probably the sole truly risk-free investment. If you own a bar of gold now, in the future you will still have a bar of gold.
Since there is no promise of a bar of gold, you aren’t relying on the word of a counter party, so there is no credit risk.
You don’t have to worry about looking for a buyer, or a seller, because quantities equivalent to the entire world's annual output change hands every day and so liquidity risk is non-existent.
The real value of gold tends to remain constant over the long term – the value of goods and services you can exchange for a bar of gold now will broadly remain the same over time, regardless of what happens to prices.
No matter what goes on in the outside word, gold stays the same, but therein lies the problem. A bar of gold now will not be any more than a bar of gold in the future.
Its nominal value may change, but in the long-term its intrinsic value remains the same. It provides no income, is of limited practical use, despite there being trace amounts in my laptop and mobile phone.
It isn’t particularly scarce, being almost infinitely recyclable; the world stock is ever expanding. Along with having almost no risk, it also has almost no growth potential.
What gold is good for, however, is as a store of value. It is no coincidence that in times of financial stress the price of gold rockets as demand spikes.
If the financial system collapses, the paper-based system of promissory notes becomes worthless and gold will be the only asset left.
Gold is the ultimate fear asset, its tremendous increases of the last few years have been driven by fear; this is the investment equivalent of stockpiling beans in a homemade bomb shelter.
Performance of gold over 5-yrs
Source: FE Analytics
The financial crisis will probably be resolved eventually; once greed returns people will dump gold for higher yielding and higher growth assets and its value will plummet.
If you are smart enough, or lucky enough, you can exploit these patterns to make short-term trading gains, but in that respect gold is no different to anything else traded on an exchange.
The most likely outcome is that you have no more or less than you started with – if you have held on to your gold for a long time. If you jumped in only recently, you will be looking at large losses.
Gold has a place then; but it is only suitable for a narrow, tightly defined investment strategy. If you have no need of growth or income, but a strong desire to preserve the real value of your portfolio, look no further – for extra peace of mind, why not put it in a safe and bury it in the garden. The remaining 99.9 per cent of us however, should look elsewhere.
Rob Gleeson is head of research at FE. The views expressed here are his own.