Money Rehab with Nicole Lapin - Why Gold is a Popular Investment and How To Invest

Episode Date: March 7, 2023

Historically, the price of gold has increased during times of economic crisis. The natural questions are: why? And, how? As in: if gold is a good investment, how do I get in on it? Rest assured, you do not need to carry gold bars around. Nicole explains the best way to invest in the asset— and it's much easier than you might think!

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It's time for some money rehab. A couple of years back, a friend's grandmother died and a new family mystery was born. Now, Bubby, that's the Yiddish word for grandmother, was a 96-year-old Jewish woman. She had lived through the Shoah and she had seen currencies be created and destroyed. and she had seen currencies be created and destroyed. So in the 80s, Bubi bought South African Krugerrands, which is the most popular gold coin in the world. These coins were never designed for use as currency. Rather, they're an easy way to invest in gold without having to buy a whole gold bar. As coins, they're easy to transport and, unfortunately for my friend's family, easy to hide. I say unfortunately because no one has ever been able to find Bubby's gold. Now, they're asking all sorts of questions like, did somebody take it? Did she hide it so well

that they haven't found it yet? Or did she sell it ages ago to pay for something she didn't want her family to know about? So many questions. I tell you this story because it highlights some of the benefits and drawbacks of gold. As you've seen, gold is back in the news as a hedge against inflation. And with the asset-making headlines again, it's a good time to do our due diligence and examine whether or not gold is as useful as the financial world believes. Let's start off with some basic gold pricing. First of all, when we talk about an ounce of gold, we're talking about a troy ounce, which is about 28 grams heavier than a standard ounce. It's how they measure precious metals. This isn't a troy ounce of melted down old jewelry. This is gold bullion,

or investment-grade gold, which has to meet specific standards called the good delivery standard, or rules about the purity, physical appearance, and weight of gold bars. These standards are set by the London Bullion Market Association. Twice a day, this group gets together digitally and holds a gold auction. The results of that auction determine the global price of gold. Now, gold is being bought and sold around the world constantly, and gold futures are being sold all the time. But the daily benchmark, that's the price that comes from London. So what drives up the price of gold? Now, gold is different from a lot of other metals or other commodities. Most of the gold that's been mined historically is still around today. It's not like coal,

where we mine it up and then burn it up, or even like copper, where about 40% of it gets recycled over a 10-year period. Gold is globally valued, yet its practical utility is limited. The lack of utility here is key. Let's use copper as a counterexample again. Copper has defined utility. Copper is used in manufacturing. So when there's more manufacturing in a country, typically the economy expands and more copper is used, and so the price of copper goes up. But you don't need gold to manufacture anything. So I'll ask again, what drives up the price of gold? There are a lot of competing theories here, and one of the most popular is that the cost of gold goes up when inflation goes up. During the 1970s, there was a global energy crisis.

Well, it's typically referred to as an energy crisis, but it really was an oil crisis. In the 70s, the Organization of Arab Petroleum Exporting Countries placed an embargo on the U.S. over U.S. support of Israel. U.S. over U.S. support of Israel. As the U.S. was almost completely dependent on foreign oil at the time, this drove up the price astronomically and created global shortages as the U.S. scrambled to source its oil from other countries. This led to the formation of massive lines at gas stations in the U.S. and rules about who could fill up on which days. This also led to widespread economic inflation of around 8.8 percent between 1973 to 1979. This was a time when people were very nervous about the future. However, during this time, annualized gold returns were an incredible 35 percent, which gave gold a reputation as being a brilliant hedge against

inflation. But those amazing returns didn't last. From 1980 to 1984, inflation averaged 6.5% annually, but gold actually fell an average of 10% every year. By 2001, any close relationship between the price of gold and 10-year inflationary expectations had totally fallen apart. When you adjust the price of gold for inflation, the relationship vanishes. Okay, so we've ruled that out. So if gold doesn't go up during times of inflation, maybe it goes up when interest rates go up. But when you overlay the change in price of gold with the 10-year treasury yield, which just FYI can be used as a proxy for interest rates, the relationship between the 10-year

yield and the price of gold falls apart by the early 2000s. In fact, when you look at the returns on gold adjusted for inflation, you would be better off buying those 10-year treasury notes. So what chart does the price of gold closely track? Well, if you track consumer sentiment, particularly pessimistic economic expectations, there is a tight relationship between the price of gold and negative sentiment. The more worried people are, the higher the price of gold goes. Because people buy gold in a crisis. Just like in the 70s, it also went up in the days after 9-11. It spiked again during the Great Recession and in 2020. Just like copper is an indicator of growth and development,

gold is an indicator that people everywhere are getting worried and probably listening to their boobie and making sure they have a little gold set aside just in case things go badly, like doomsday badly. Now, gold is a global market. A bunch of banks meet in London and set the price in U.S. dollars. But most of the world's gold actually comes from Russia. So obviously, over the last year, there have been major shifts within the global gold market. Many funds have attempted to divest from Russian gold. Last year, the G7, that's the Intergovernmental Political Forum that consists

of the U.S., U.K., Canada, France, Germany, Italy, and Japan, plus they also let reps from the EU sit at the table, issued a number of sanctions against Russia as a result of the invasion of Ukraine. This included a ban on buying gold from Russian mines. While this would seemingly limit the amount of gold available in the global markets, in practice, it just shifted the trade patterns. China and other countries in Asia are happy to buy up Russian gold, especially with fewer global competitors. China in particular has added almost $10 billion in gold to its reserves over the last year. Many of the sanctions against Russia limited its ability to conduct business in a global market. It makes

sense that countries like China are stockpiling gold as a way to store value even if they are cut off from the global market. So here's the best way to think about gold. Gold is best as a store of value rather than an investment. It's a place to park some money with the idea that the money will stay there safe. You're not investing in gold to flip it and make money. You're investing in gold for the same reason Bubi and China did, so that when things go sideways, you have a store of safe money. While gold prices spiked in 2020, they have been trading sideways or slightly down since then. They're slightly down over the last month, but it seems pretty inevitable that they will spike again in the next crisis. So gold can be seen as part of a wider safety net for when things go wrong.

If you're sold on gold and you do want to incorporate it into your portfolio, there are a couple of ways you can do that. The easiest way is to purchase shares of a gold ETF from your brokerage or in your retirement account. These ETFs or exchange-traded funds function in two ways. Some track the price of gold, while others invest in shares of publicly traded gold mining companies. You can go to your brokerage account, search for gold ETFs, and then look up their performance over time and the type of assets they track. The ones that track the price of gold buy gold and store it. You can buy a share of that, and the advantage is you don't need to buy or store actual gold yourself. And when you want to sell it, you just

have to sell your shares, not find a buyer for your gold bar. Generally, I don't recommend investing in individual stocks and buying shares in a gold ETF that owns shares of gold mines or gold mining companies as a way to benefit from the rise in the shares of gold mines or gold mining companies is a way to benefit from the rise in the price of gold without actually buying individual shares. Again, this is a far more liquid way to benefit from the rise in gold prices without keeping or hiding gold bars or coins around the house. For today's tip, you can take straight to the bank. While some folks from the

old country knew the value of having a little bit of gold around the house in case things went really sideways, I do recommend keeping a little bit of cash on hand in case, say, the power goes out and you need to pay for water or gas. You can also keep emergency money on a prepaid credit card. In a fire, gold can melt or be hard to recover. It can also get lost. But if you keep some of your emergency funds on a prepaid credit card, you can call the company and have the card replaced in case of an event like a fire. Money Rehab is a production of Money News Network.

I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Lavoie. Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.