Gold loses its value

goldCapital Explains: What You Need To Know About The Price Of Gold Now

In our seriesCapital explainswe give a condensed overview of current economic topics. This time: Deutsche Bahn and local public transport - with an editor Stefan Schaafwho writes at Capital on monetary policy and finance, among other things.

Gold is generally considered a safe investment. When is the best time to buy gold?

Basically not when there is a crisis. Gold is expensive then. Let's take a step back: Gold actually has a reputation as a safe investment, which is ultimately due to the fact that many have this unshakable belief in gold as an investment. In itself, however, we are dealing with an industrial material that is also necessary for cell phone production. Anyone who buys gold bars or coins has great confidence that they will retain their value. That was gold in the past and probably will be in the future. But one should keep in mind that gold lives from this trust.

Anyone who feels good about investing in gold is advised to prepare for crises in the long term. As you do with many other things. I don't just take out home insurance if the burglar is already in the apartment. Likewise, one should buy gold when the situation on the capital markets is calm. Then gold is relatively cheap. So when the DAX is high or even reaches record levels, buying gold is most likely to be recommended. Gold only has a stabilizing function in a crisis if it is bought before the crisis.

The price has to rise to maintain its value

Since the corona crash on the financial markets, some private investors are increasingly relying on buying gold. Is this a good idea?

Fear is always a bad advisor. In a crisis, in which fear is often a side effect, you should never suddenly start turning your belongings into gold. If you are saving and investing over the long term, it makes sense to invest some of your money in gold. There are, for example, mixed funds that invest part of their assets in gold. If you save them regularly, the gold contained in small parts can take on a stabilizing function.

But when stock markets plummet, buying gold is never advisable. That was the case with the DAX during the crisis. Then the gold price usually rises, which simply makes the purchase too expensive. Gold does not generate any income, as you know from stocks, where you get dividends. Unlike real estate, which generates rental income, or savings accounts on which I may receive interest, gold does not bring me any income. So in order to maintain the value of gold in the long term, the price must also rise. “You have to find the next stupid person,” they say in the capital markets, sometimes condescendingly.

Then there are the costs of owning gold. I need a safe at home or I have to pay to rent a safe deposit box. Keeping gold at home gets on your nerves. And finally, gold dealers must also be able to cover their costs, for example for advertising. This leads to the so-called buyer's premium, i.e. the range between the purchase and sales price. These are usually between three and four percent. During the crisis, a premium of eight to 15 percent was recorded. The gold price has to rise massively so that there are no losses.

Gold price climbed to a record level

At the beginning of the Corona crisis, the gold price initially fell by ten percent. How come?

Right. To understand this, we need to know that retail investors are not critical to the gold market. Professional investors often make their share purchases with loans - and when prices fall, they have to monetize whatever investments they have. That is why they also sold gold at the beginning of the corona crash. That caused the price to drop rapidly. In really difficult times of crisis - Armageddon, which the crash prophet likes to write about - the gold price is likely to plummet anyway, as many have to sell their gold. We basically know this from the post-war period, when people exchanged their valuables or silver cutlery for potatoes and other groceries.

How much does the rush for gold affect the gold price?

When we speak of "the gold price", we usually mean the London gold price - called the bullion. It reflects the trading of institutional actors. Soon after falling in March, the price of gold quickly climbed to record levels. During the crisis phase, there was a rush for investment products such as Xetra-Gold as well as physical gold in the form of coins and bars. I have already explained why this is bad business for investors. An important factor for the gold price is the development of interest rates. If there is no interest on the overnight money account, I can also invest in the unprofitable gold. However, if I get 2 percent interest, gold loses its attractiveness in comparison. In this case, economists speak of opportunity costs - i.e. the costs of not accepting the opportunity of 2 percent interest because you are investing in gold.

The higher the interest rate, the less useful it is to invest in gold. So you should always keep an eye on interest rate developments. In addition, this idea shows that, contrary to what some sellers claim, gold is not a very good protection against inflation - at least as long as central banks take their mandate of price stability seriously and raise key interest rates when prices rise. However, if interest rates rise, the price of gold may well fall.

Distribution of risk

Is it still worth buying gold after the gold price has risen?

A purchase is now more worthwhile than at the record levels at the end of March. Nevertheless, I would recommend that those who want to buy gold should invest half of the money planned for the gold purchase now and then buy the rest in a few months. That spreads the risk of buying something too expensive.

Are there alternatives to coins and bars?

In any case. Another option would be to invest in an Exchange Traded Products (ETP). This is a product similar to the ETF that holds real gold. If the issuer goes bankrupt, the gold could be sold and the investors paid out. The advantage is that these products are very cheap for investors and therefore do not incur the high costs of buying and storing coins and bars as well as the considerable premium when buying.