Rightly or wrongly, investing in gold is often compared to investing in cash. This is in part because gold has been used as money for thousands of years and often it trades like a currency although it also has some of the traits of a commodity.
Regardless of how you choose to categorize it, gold is often considered a currency. The summary below clears up some common misperceptions about gold, relative to cash, and shows that, when the concerns of the average persons with respect to cash are taken into account, well …. Gold comes out on top!
Defining Gold versus Cash
When gold is compared to cash, most people don't realize that there are two main different ways of holding gold bullion in a bank account: (1) allocated gold and (2) unallocated gold. Using this terminology, cash on deposit at a bank is technically "Unallocated Cash". Therefore, one should compare unallocated gold to cash on deposit. However, I am going to compare Allocated Gold to Cash on Deposit as most people who think of gold, think of it sitting in a vault, not being lent out and therefore not collecting a return.
Allocated gold is not lent out
One of the main reasons you keep money in the bank is that it (hopefully) pays a rate of return, the interest rate. Modern finance theory tells us that in simple terms, the greater the risk, the higher the return should be. Cash on deposit earns a rate of return because the bank lends out your cash - in effect you have loaned the bank your own cash. That is why you earn interest on it. The bank lends out this money at some multiple (in excess of 10 times) greater than its total deposits. You have just taken a risk on (1) the banks credit worthiness and (2) that the bank has made a good decision to lend out this money. The more money the bank lends out, or the higher the credit risk of the person/institution to whom the bank has lent the money, then the more risk you have taken on by depositing cash at the bank. The only control you have over this risk is by not keeping your cash on deposit with the bank. This is similar to unallocated gold: it is lent out to a 3rdparty, often to a multiple of what is actually on deposit, and it earns a rate of return which is called the lease rate.
By comparison, allocated gold is not lent out, does not carry any credit risk on the bank or a 3rdparty, and therefore does not earn any income. Indeed, allocated gold may bear a holding charge to cover the costs of storage and insurance.
The bank owns your cash
If you deposit allocated gold with an institution, you own the gold. You can turn up to the bank and demand your gold to be delivered to you. It is like holding it in your own safety deposit box.
Cash on deposit, on the other hand, is not owned by you. It is owned by the bank and therefore if your bank went into bankruptcy, then all cash on deposit with the bank would be shared amongst its creditors (unless it is bailed out by the government or through insurance). Having cash on deposit means that you rank as an unsecured creditor of the bank. Furthermore, if everyone demanded all their cash from the bank at the same time, there would not be enough cash to pay people. In small amounts, you can usually demand your cash, however even in modest amounts, cash cannot be paid on demand.
Gold is always accepted
Provided that gold has its authentication verified, gold has always been accepted. It has been used as a store of wealth and as a currency for many thousand years. And as Alan Greenspan said in May 1999:
"Gold still represents the ultimate form of payment in the world …..
Gold is always accepted."
In contrast, cash is not always accepted. The other day I withdrew £100 in 5 £20 notes from a banking machine. I then walked to the store to buy a sandwich for lunch. When I went to pay for my lunch I was told that the first £20 note I took from my wallet was not acceptable - I didn't know that it was an "old note"! A note which I had withdrawn from the bank five minutes earlier had not been accepted…. Yet gold is still used as a currency today. Gold is gold.
Gold is also accepted anywhere in the world. It can be a currency without borders. Cash has borders and this is most pronounced when the government is unstable, the currency is not liquid or the government is printing too much money. Upon reflection, I thought that none of these applied to the British Government yet my £20 note was still not accepted.
Gold is relatively scarce
Without getting too deep into the debate as to whether gold has scarcity value, it is worth pointing out that Gold Fields Minerals Services (GFMS) estimate that only about 150,000 tonnes of gold has ever been mined. At a gold price of US$370/oz, this values the total world gold stock at US$1.7 trillion. To put this in context, the total cash stock (M1 money - being cash & checkable deposits) in the United States is approximately US$1.3 trillion. Knowing that money exists in every country and how that money is multiplied, I would suggest that gold is scarce, relative to cash.
Gold is produced, money is printed
Gold forces discipline; gold's production process from exploration through to the minting of gold bars can take as long as 30 years, but let's say that it generally takes 10 years. Compare this to cash, which can be printed at will by each of the world's governments. On this subject, consider the famous remarks by Governor Ben S. Bernanke (of the Federal Reserve Board), before the National Economists Club, Washington, D.C., November 21, 2002:
"Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services."
Gold is subject to price risk, but so is cash
Unfortunately most people remember the years between 1980 and 2000 when gold fell from a daily high of US$800/oz to lows of US$250/oz. Gold has price risk but it can also appreciate.
People often forget that cash also has price risk. A currency's value (say the US$) is relative to other currencies or what the US$ can buy in terms of goods and services. Currently, the value of the US$ is falling against other currencies, making its value to international investors less attractive and making goods and services for US citizens more expensive. Cash has price risk too.
Gold is more secure
Investors holding gold in an allocated gold account are provided with the exact identification numbers of each gold bar they own: manufacturer, purity, and bar number. This gold is physically segregated from other gold in the vault and this gold can be insured.
Cash on deposit is not physically segregated. Your cash is mixed with other people's cash and you rely on the bank's accounting system to record details of your cash balance correctly. You are not provided with individual serial numbers of every note held on deposit for you and often the cash is not insured - do you insure your cash in the bank? Have you asked for proof (identification numbers) of your cash on deposit? And have asked the bank manager to keep your cash physically separated in an individual safety deposit box?
Below is an example of allocated gold. The photo shows a picture of actual gold bars held for an account at a major bullion bank and the table above it shows the bar identification numbers given to the customer.
It is not surprising that gold has been accepted as a form of payment for thousands of years: gold is indestructible, fungible, easy to store, liquid and secure. More importantly, gold is better than cash.
Nik Bienkowski CFA
Head of Institutional Investment
Gold Bullion Limited
October 15, 2003
This information does not constitute financial advice. You should obtain your own independent financial, taxation and legal advice before making any decisions about investing in gold. This information is not an offer for investment in gold and should not be used as the basis for any investment decision.
Under the right circumstances, buying gold can have several advantages. Hedge against inflation: As inflation increases prices, purchasing power decreases. So, if you have cash, you're effectively losing money. Gold, on the other hand, is often considered a hedge against inflation.Why is gold better than paper money? ›
Gold is not a fiat currency.
Fiat currencies derive their worth from the issuing government. Unlike paper money, gold cannot be expanded to suit the needs of struggling central banks. Due to its inherent scarcity, gold will always be supported.
Physical gold stored by the owner isn't subject to fraud and generally (looking at history) as inflation rises so does the price of gold, which is renowned as an investment product to use to hedge against inflation. Gold is the same worldwide, there is no need to convert at a cost into a local currency.Why is gold the best asset? ›
Gold and other precious metals have long been considered a smart way to fight inflation. That's because it tends to hold its value and preserve your purchasing power over the long haul, despite fluctuations in the dollar.What are the advantages of gold? ›
- Hedge Against Inflation. When you invest, you must keep in mind the impact inflation will have on your returns. ...
- Multiple Options to Choose From. Your investment in gold does not have to be physical. ...
- Helps Diversify Your Portfolio. A diversified portfolio reduces your investment risk. ...
- High Liquidity.
Many people find gold to be a good investment because it can act as a diversifier in a typical portfolio. It can act as a hedge during periods of high inflation and as a safe haven during market volatility. But it also does not earn income and can be subject to fluctuations in value.Is gold worth more than a Dollar? ›
The price of gold is generally inversely related to the value of the U.S. dollar because the metal is dollar-denominated.Should I convert cash to gold? ›
It's a Good Balance for a Cash-Heavy Portfolio
If the bulk of your current investments are in cash in one form or another, converting some of that cash to gold can be beneficial. It's a great way to round out your portfolio so you're not entirely dependent on cash.
Key Takeaways. Fiat money is a government-issued currency that is not backed by a commodity such as gold. Fiat money gives central banks greater control over the economy because they can control how much money is printed. Most modern paper currencies, such as the U.S. dollar, are fiat currencies.How much gold should I own? ›
In general, though, financial experts often recommend putting between 5 and 20% of your portfolio into gold or other precious metals, though some suggest an even greater allocation.
Gold vs Silver Comparison Table. Gold is a less volatile, more dependable investment for long term investors. Silver is more volatile, which means for short term investing better gains can be made. The spot price of gold is always considerably higher than silver and is less dependent on the markets.How much of your money should be gold? ›
Gold is an asset that is inversely correlated with the market. It does well during economic slumps. This is why investors prefer to add gold to their portfolio - to hedge against inflation. Most estimates suggest that gold investments should make up only 5-10% of your portfolio and not more.Why is everyone investing in gold? ›
Gold is usually seen as a safe haven for investors in times when other markets and economies are facing challenges, and during inflation, gold is seen as a hedge against it— when inflation begins to outpace interest rates, investors seek to put their money in more stable investments.Is buying gold better than a savings account? ›
To protect themselves from inflation, central banks buy gold. The central bank demand for gold exploded in 2022, reaching its highest level in 55 years! Due to its scarcity, gold has intrinsic value. That means gold won't lose value over time, and maybe even appreciate, unlike money you keep in your savings account.What time is good to buy gold? ›
You can see that on average, gold tends to surge during the first couple months of the year. The price cools down through the spring and summer, then takes off again in the fall. This means that on a historical basis, the best times to buy gold are early January, March and early April, or mid-June to early July.Why is gold better for money than silver? ›
While no major economy uses gold or silver as the basis for its currency any longer, investors still see these two metals as active stores of value. Silver is more volatile, cheaper and more tightly linked with the industrial economy. Gold is more expensive and better for diversifying your portfolio overall.