Valuable as they may have been 2,000 years ago, you don’t hear much about Frankincense and Myrrh in the financial press these days. Gold, on the other hand, remains an important player in global financial markets. Why is this?
As a metal, gold’s unusual properties include extreme malleability and near indestructibility (it does not oxidize in air or water). These traits, along with its brilliant color, have made gold a favorite choice for adornment (jewelry and gilded works of art) and currency since the beginning of civilization. More recently, gold’s utility as a conductor has increased demand for the metal in electrical components, including computer boards and high fidelity audio and video connectors.
None of this, however, accounts for gold’s value, which currently hovers around $1,100 per Troy Ounce. Jewelry and electrical connectors can be made from many metals, and currency today is generally decreed by fiat – backed by the authority of states rather than by reserves of precious metal. Even gold’s scarcity – only 161,000 metric tons are known to have been mined in human history – does not account for the metal’s hold on the human imagination. (National Geographic notes that 161,000 metric tons of gold is barely enough to fill two Olympic swimming pools).
And it is indeed the human imagination that seems to determine the value of gold. Gold is widely accepted as a “store of value” and a hedge against deflation (and sometimes against inflation), apparently because it is widely accepted as such. Since its value does not correspond to its utility, gold could be considered a fiat currency like any other. Of course, if value was determined exclusively by basic traits and common agreement, then Hostess Twinkies could compete with gold as a store of value and hedge investment, since they share a pleasing color, extreme malleability, near indestructibility, and a desirous following. The worldwide breadth of desire for gold makes the metal’s value the ultimate “gentleman’s agreement.”
Swiss financial services giant UBS notes that “For much of the modern era (since 1500), currencies have been – officially or unofficially – priced off a gold standard, that is to say currencies were backed and/or convertible into gold.” As a result, central banks all over the world hold huge inventories of gold. As UBS explains, “Gold is divisible, indestructible and transportable; furthermore, it can be stored indefinitely, all of which makes it unique as a convenient agent of exchange.” Twinkie fans might dispute the uniqueness of gold in these regards, but as legendary investor Bernard Baruch put it, “Gold has worked down from Alexander's time... When something holds good for two thousand years I do not believe it can be so because of prejudice or mistaken theory.” We may not understand precisely how gold maintains its hold on the world’s imagination, but for over two thousand years it has done so, and that makes gold’s place in the financial markets of special interest to all investors. In part 2, we’ll examine the roles gold might play in an entrepreneurial investor’s overall portfolio