Investing in gold

The asset that shines in troubled times

John Stepek

13 October 2007

John Stepek says the price of gold is a gauge of investment fear — and there’s a lot of fear around right now

But why? Gold makes no sense as an investment. The point of most investment assets is that they generate income. The price that a sensible investor is willing to pay for an asset should reflect the amount of future income it is expected to provide. An investment property is supposed to pay the owner a rent — though not always, as many city-centre buy-to-let amateurs are finding to their cost. You buy shares in a company either because it pays a dividend or because you expect it to reach a position where it pays a dividend in the future. Even current accounts (effectively a loan to the bank, as Northern Rock account-holders have learnt rather vividly in recent weeks) pay some minimal level of interest.

Gold doesn’t pay anything. In fact, gold costs the owner money, in the form of charges for storage and insurance. The only possible way to make money from gold is if you can sell it for more than you bought it for.

However, this misses the point. Gold is better seen as an insurance than as an investment. Gold tends to become more popular when investors are worried about the possibility of a financial crisis. Think of the gold price as a gauge of investment fear — and with an ounce of gold currently selling at a 28-year high of more than $740, there’s a lot of fear around.

Northern Rock was just a very obvious symptom of a much deeper problem currently facing the global financial system. Massive bad debts, which have been built up by banks lending carelessly to the sub-prime end of the US housing market, have been spread far and wide across the world through the use of credit derivatives. With no one really sure of where these losses are going to spring up next, banks have suddenly become much more picky about who they lend to. But the property bubbles currently afflicting most Western countries have been built on easy lending. Soaring house prices have also fuelled a consumer boom on both sides of the Atlantic, leaving much of the population reliant on credit lines which are now rapidly going to be taken away from them.