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Gold - First Among Equals

| 11/5/2012 10:54 AM Monday

Gold prices, which began rising at the beginning of this millennium, have not turned around since then. Even after 12 years, the prices of gold only seem to be rising in what can best be described as a unidirectional move to the top. From an average of USD 271/troy ounce during 2000, the price of gold is currently at USD 1725/troy ounce – an average rise of 18.3 per cent per annum since 2000. What this means is that gold has well performed its primary task of beating inflation. Besides this, it has also managed to surpass the returns provided by various other asset classes including equity, which returned 15 per cent during the same period. There are very few instances in history where gold has consistently outperformed other asset classes over such a long time.

In fact, a look at gold prices over a period of time suggests that they have remained stable for most part of history. For example, the price set by Isaac Newton (English physicist, mathematician and astronomer, best known for the falling apple and the law of gravitation) in 1717, as master of the UK Mint, remained almost same for the next 200 years. Even after that, the prices of gold did not fluctuate much till 1973, when the Bretton Woods system of fixed exchange rates collapsed and gold prices were determined by market forces. In 1990s too, the prices of gold either remained stable or went up.

Therefore, the current surge in the price of gold poses a very natural and logical question. When will the law of averages catch up, and how long will the current bull run of gold sustain? More so, is this the right time to invest in or buy gold?

To find out answers to these questions, we need to first understand why gold, despite being a commodity, displays characteristics different from other commodities, and hence, how the factors that determine its prices are not just the simple economic principles of demand and supply.

A Unique Commodity

One of the factors that single out gold from other commodities is that unlike other commodities, gold does not perish or degrade over time. This gives it a unique property of being a very long-term store of value. Gold mined today is interchangeable with gold mined at any time ever over thousands of years.

Another unique feature of gold that makes it less price elastic is its supply. The supply of gold has been relatively fixed for quite some time now. Unlike other commodities, there is a very negligible possibility of increasing the supply of gold to manage prices.

Another important attribute of gold is its relatively less prominent use for industrial purposes as compared to other commodities including precious metals like silver and platinum.

Moreover, with a steep increase in the price of gold, only around two per cent of gold demand in 2010 came from industrial uses and the balance of the demand arose from jewelery and for investment. As a result, gold prices has often exhibited a very low or even negative correlation with economic cycles and with other financial assets (See table: Correlation of Annual Returns Since 1972).

 

Find More Articles on: Commodities, DSIJ Magazine, Special Report, Gold Strategy, Product, Mid Cap

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