Why does gold have value?

Question

I'm curious about why is there so much financial interest and news coverage about gold.

It's hard to do things like buy food or pay the rent with gold, but I can do this with cash. Gold doesn't yield income like bonds. When I buy a corporate stock, I have faith that the company will grow, prosper, sell products, etc. and this will increase the value of my stock. Gold doesn't grow in value like a corporate stock.

So why does gold have such a high value? Why does the value of gold go up when gold itself doesn't produce anything? Why do people invest in gold?

I realize that this question might be viewed as provocative by some, but my intention is to ask this as a financial education question. I really do want to understand this ;)

Answer 1

Gold's value starts with the fact that its supply is steady and by nature it's durable. In other words, the amount of gold traded each year (The Supply and Demand) is small relative to the existing total stock. This acting as a bit of a throttle on its value, as does the high cost of mining. Mines will have yields that control whether it's profitable to run them. A mine may have a $600/oz production cost, in which case it's clear they should run full speed now with gold at $1200, but if it were below $650 or so, it may not be worth it. It also has a history that goes back millennia, it's valued because it always was. John Maynard Keynes referred to gold as an archaic relic and I tend to agree. You are right, the topic is controversial.

For short periods, gold will provide a decent hedge, but no better than other financial instruments. We are now in an odd time, where the stock market is generally flat to where it was 10 years ago, and both cash or most commodities were a better choice. Look at sufficiently long periods of time, and gold fails. In my history, I graduated college in 1984, and in the summer of 82 played in the commodities market. Gold peaked at $850 or so. Now it's $1200. 50% over 30 years is hardly a storehouse of value now, is it? Yet, I recall Aug 25, 1987 when the Dow peaked at 2750. No, I didn't call the top. But I did talk to a friend advising that I ignore the short term, at 25 with little invested, I only concerned myself with long term plans. The Dow crashed from there, but even today just over 18,000 the return has averaged 7.07% plus dividends. A lengthy tangent, but important to understand.

A gold fan will be able to produce his own observation, citing that some percent of one's holding in gold, adjusted to maintain a balanced allocation would create more positive returns than I claim. For a large enough portfolio that's otherwise well diversified, this may be true, just not something I choose to invest in. Last - if you wish to buy gold, avoid the hard metal. GLD trades as 1/10 oz of gold and has a tiny commission as it trades like a stock. The buy/sell on a 1oz gold piece will cost you 4-6%. That's no way to invest.

Update - 29 years after that lunch in 1987, the Dow was at 18448, a return of 6.78% CAGR plus dividends. Another 6 years since this question was asked and Gold hasn't moved, $1175, and 6 years' worth of fees, 2.4% if you buy the GLD ETF. From the '82 high of $850 to now (34 years), the return has a CAGR of .96%/yr or .56% after fees. To be fair, I picked a relative high, that $850. But I did the same choosing the pre-crash 2750 high on the Dow.

Answer 2

Because people are willing to trade for it. People are willing to trade for Gold because:

• It's aesthetically appealing.
• It's useful (electronic and engineering applications)
• It's long lasting (it doesn't corrode, or deteriorate appreciably).
• It has semantic value (because we culturally believe gold is valuable).

The value of gold goes up because the demand for it goes up, while the supply has been basically static (or growing at a low static rate) for a long time. The demand is going up because people see it as a safe place to put their money.

Another reason Gold's value in dollars goes up, is because the value of the item it's traded against (dollars, euros, yen, etc) goes down, while its own value stays roughly the same.

You point out Gold is not as liquid as cash, but gold (both traded on an exchange, and held physically) is easily sold. There is always someone willing to trade you cash for gold. Compare this to some of the bank stocks during the first part of our current recession. People were not willing to give much of anything for your shares. As the (annoying, misleading) advertisements say, "Gold has never been worth zero".

Answer 3

A lot of people probably don't agree with him, but Warren Buffett has some great quotes on why he doesn't invest in gold:

I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about seven Exxon Mobils, and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.

And his classic quote:

[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

Answer 4

I think the primary reason it is so pricey now is that it is an inflation hedge, and considering how shaky the economies and out of control the spending is in many countries right now, people are running to it as a safe harbor. The increased demand raises the price as it does with any asset.

This brings us to the titular question. Why does gold have value? The same reason anything has value. There is someone out there who wants it enough to trade something else of value to get it.

It is in the news so much because it is so high right now, which unfortunately is going to cause a lot of people to foolishly invest in it at likely the worst possible time.

Answer 5

Gold has value because for the most of the history of mankind's use of money, Gold and Silver have repeatedly been chosen by free markets as the best form of money. Gold is durable, portable, homogeneous, fungible, divisible, rare, and recognizable.

Until 1971, most of the world's currencies were backed by Gold. In 1971, the US government defaulted on its obligation to redeem US Dollars (by which most other currencies were backed) in Gold, as agreed to by the Bretton Woods agreement of 1944. We didn't choose to go off the Gold Standard, we had no choice - Foreign Central Banks were demanding redeption in Gold, and the US didn't have enough - we inflated too much.

I think that the current swell of interest in Gold is due to the recent massive increase in the Federal Reserve's balance sheet, plus the fast growing National debt, plus a looming Social Security / Medicare crisis. People are looking for protection of their savings, and they wish to "opt-out" of the government bail-outs, government deficits, government run health-care, and government money printing. They are looking for a currency that doesn't have a counter-party.

"Gold is money and nothing else" - JP Morgan

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard." - Alan Greenspan

Answer 6

"Everything is worth what its purchaser will pay for it." --Publilius Syrus.

Gold has value because people want to buy it. Electronics manufacturers like the fact that it's conductive. Jewellers like that its shiny. Glenn Beck likes that he's selling it and his audience will buy it.

Proponents of gold claim that it has "real" value, as opposed to fiat currency (which has no commodity backing). Opponents of gold claim that all wealth is illusory, and that gold has no more inherent value than the paper we use now. I'm inclined to agree with the latter (money is only money because we agree that it is, and the underlying material is meaningless), however the issue is hotly debated.

Answer 7

I use to play marbles at school. Marbles were like gold the more you had the richer you were. They were a scarce commodity only a few in circulation. Once I secured a wealth of marbles I realized they were of little real value. They were only of illusory value. As long as we all were deceived into believe they had value they I was rich. Sure marble could be used to make marble floors ;) they were lovely to look at, and every one wanted them. Then one day, I discovered the emperor had no clothes. Wow, the day that everyone sees the true value of gold, what a stock market crash that will be. I tried to avoid gold as much as possible, but this is hard to do in todays stock market. My solace is that we will all be in the same golden (Titanic) boat, only I hope to limit my exposure as much as possible. Anyone want a gold watch for a slice of bread?

Answer 8

To start with gold has value because it is scarce, durable, attractive and can be made into jewellery. But that does not explain its current value. In the current economic climate, it is difficult for many investors to get a positive return on conventional investments such as equities or bonds. I theorise that, in such conditions, investors decide to park their money in gold simply because there are few other good options. This in itself drives the price of gold up, making it a better investment and causing a speculative boom. As you will see here, here, and here the gold price is negatively correlated with stock market indices.

Answer 9

"It has semantic value (because we culturally believe gold is valuable). "

There is a very important point here. Gold and many other coin metals.

This "semantic value" is enshrined in law through the special tax status of coin metals. You can buy a kilo of gold and not pay sales tax. You can't buy a kilo of iron or tin and do the same. This is the important part because investors shouldn't care about semantics.

I read that the taxable status varies by state or nation, so you need to be very careful. It's possible to evade taxes without realizing it. It also doesn't necessarily exempt you from the form of gold. An ingot should be tax exempt. A collector's coin may or may not be, depending on your local laws and the difference between the value of the weight of the gold, and the value of the form of the coin.

Answer 10

Why does the value of gold go up when gold itself doesn't produce anything? Why do people invest in gold?

Your perception, that the value of gold goes up in the long run, is based on the price of gold measured in your favorite paper currency, for example the US Dollar.

An increasing price of gold means that in the visible gold market, market participants are willing to exchange more paper currency units for the same amount of gold.

There are many possible reasons for this:

• more people want gold
• paper currency units are printed out of thin air, chasing for the same (or very slowly growing) amount of gold.
• High Frequency Trading (HFT) programs that gain from price movements and not primarily from the price itself.
• decreased productivity of an economy.
• ...

While HFT became extremely important for the short term price movements, I will continue with long term effects, excluding HFT.

So when - as a simple thought experiment - the amount of available paper currency units (US $ or whatever) doubles, and the amount of goods and services in an economy stay the same, you can expect that the price of everything in this economy will double, including gold.

You might perceive that the value of gold doubled. It did not. It stayed the same. The number of printed dollars doubled. The value of gold is still the same, its price doubled.

Does the amount of paper currency units grow over time? Yes: https://research.stlouisfed.org/fred2/series/BASE/

In this answer my term "paper currency units" includes dollars that exist only as digits in bank accounts and "printing currency" includes creating those digits in bank accounts out of thin air.

So the first answer: gold holds its value while the value of paper currency units shrinks over time. So gold enables you to pass wealth to the next generation (while hiding it from your government).

That gold does not produce anything is not entirely true. For those of us mortals who have only a few ounces, it is true. But those who have tons can lease it out and earn interest. (in practice it is leased out multiple times, so multiple that gain. You might call this fraud, and rightfully so. But we are talking about tons of gold. Nobody who controls tons of physical gold goes to jail yet).

Let's talk about Fear. You see, the perceived value of gold increases as more paper currency is printed. And markets price in expected future developments. So the value of gold rises, if a sufficient number of wealthy people fear the the government(s) will print too much paper currency.

Second Answer: So the price of gold not only reflects the amount of paper currency, it is also a measurement of distrust in government(s).

Now you might say something is wrong with my argument. The chart mentioned above shows that we have now (mid 2015) 5 times as much printed currency units than we had 2008. So the price of gold should be 5 times as high as 2008, assuming the amount of distrust in governments stayed the same.

There must be more effects (or I might be completely wrong. You decide). But here is one more effect:

As the price of gold is a measurement of distrust in governments (and especially the US government since the US Dollar is perceived as the reserve currency), the US government and associated organizations are extremely interested in low gold prices to prove trust.

So people familiar with the topic believe that the price of gold (and silver) is massively manipulated to the downside using high frequency trading and shorts in the futures markets by US government and wall street banks to disprove distrust. And wall street banks gain huge amounts of paper currency units by manipulating the price, mostly to the downside.

Others say that countries like china and russia are also interested in low gold prices because they want to buy as much physical gold as possible. Knowing of the value that is not reflected by the price at the moment.

Is there one more source of distrust in governments? Yes. Since 1971, all paper currencies are debt. They receive their value by the trust that those with debt are willing and able to pay back their debt. If this trust is lost, the downward manipulation (if you think that such a thing exists) of the gold and silver prices in the futures markets might fail some day. If this is the case (some say when this is the case). you might see movements in gold and silver prices that bring them back to equilibrium with the amount of printed paper currencies.

In times of the roman empire you got a good toga and a pair of handmade shoes for an ounce of gold. In our days, you get a nice suite and a good pair of shoes for an ounce of gold. In the mean time, the value of each paper currency in the history of each country went to zero and the US $ lost 98% of its initial value.

As long as there is not enough distrust, more paper currency is made in equity markets and bond markets on average. (Be aware that you earn that currency only after you were able to sell at this price, not while you hold it)

Gerd

Answer 11

Most of the answers here reflect a misunderstanding of what gold actually is from a financial perspective. I'll answer your question by asking two questions, and I do challenge you to stop and think about what we mean when we say "cash" or "unit of exchange" because without understanding those, you will completely miss this answer.

In 1971, the DXY was 110. For people who don't know, the DXY is the US Dollar Index - it weighs the strength of the US Dollar relative to other currencies. Hey look, it's a pretty graph of the DXY's history. In 1971, gold was $35 an ounce.

The DXY is 97 today. Gold is $1170 an ounce today.

Now the questions:

If shares of Company A in 1971 were $10 a share, but now are $100 a share and some of this is because the company has grown, but some of it is because of inflation and the DXY losing value, what would the value of the company be if it was held in grams of gold and not dollars?

Benjamin Graham, who influenced Warren Buffett, is a "supposed" critic of gold, yet what percent of his life were we not on a gold standard? In his day, the dollar was backed by gold - why would you buy gold if every dollar represented gold.

Finally, consider how many US Dollars exist, and how few metric tonnes of gold exist (165,000). Even Paul Volcker admitted that a new gold standard would be impossible because the value of gold, if we did it today, would put gold in the $5000-$10000 range - which is absurd:

To get on a gold standard technically now, an old fashioned gold standard, and you had to replace all the dollars out there in foreign hands with gold, God the price, you buy gold, because the price of gold would have to be enormous.

So, you're all left hoping the Federal Reserve figures how to get us all out of this mess without causing trouble, otherwise, let me just kindly say, you WILL realize the value of gold then.

As the old saying goes, "A fool and his money are soon parted." I could be wrong, but I'd say that those who've been buying gold since 1971 for their "cash holdings" (not index funds) aren't the suckers.

Answer 12

Gold has very useful physical properties for some engineering applications. Even tiny amounts of gold can substantially improve products, so it can be worthwhile to pay high prices per ounce for gold. For example:

• Gold can be "beaten" or electroplated to produce very thin shiny coatings. Entire roofs (of famous buildings) have been covered with "gold leaf", at a cost that was small compared to the supporting structure.

• A very thin layer of electroplated gold provides better protection against corrosion than a much thicker layer of electroplated nickel. Even if gold costs thousands of times more per ounce than nickel, it is cheaper to use gold as an anti-corrosion layer than nickel (for use in military-grade naval electronics).

• A thin layer of electroplated gold greatly increases the electrical current-carrying capacity of a thin copper wire.

Answer 13

Gold can be thought of to have value in one of two ways; (1) as a means and (2) as an end.

Means takes the shape of currency. In this form, we value gold in the same way we value the dollar, it allows us to purchase things we want. As a medium of exchange, gold has no definitive value and is only assigned one during the process of an exchange. For example, I would be valuing one ingot of gold to be worth a dog if I traded a dog for one ingot of gold. The value of gold in this sense is subjective as each person decides for themselves what gold is worth during the transaction.

Gold as an end is valued for its own sake. A good example of this is a jeweler who purchases gold directly because of the intrinsic property(s) gold possesses. This is closer to the "true value" of gold than using it as a means, but virtually no one in our society views gold in this manor because virtually no one can use gold in this manor. "You know what I could use right now, a block of gold." - said no one ever.
But even if you are one of the select few who value gold for its own sake, this is usually done because gold provides a function. For example, if people no longer want to ware jewelry, then a jeweler will likely have to find a new line of work where he would likely no longer view gold as valuable as an ends.

To sum up, gold has a perceived value for most people and an "intrinsic value" to a select few (for the time being).