The Story of Gold and its place in Investment Portfolios

A Champion Metal

Despite humanity’s furious mining and search for Gold that started 4,000 years ago, there is not much Gold on earth relative to other elements. The science writer Theodore Grey writes in his superb book, “The Elements – A Visual exploration of every known atom in the Universe,” “All the gold ever mined in the history of the human race would fit into a cube about 21 meters on edge.” (This figure has been updated for production up to 2020)

In addition to shining out brightly, Gold also has a combination of properties that makes it stand out. It keeps its brilliant color, it is malleable (it can be made into different shapes), it is resistant to acids, and it conducts electricity without rusting and so used in high-end electronic devices.

Theodore Grey writes, “You can find a piece of Gold lying on the ground where it has been for a million years, pick it up, dust it off, and it will shine for you as it’s been waiting the whole time for this moment. Billions of years from now, when aliens come to the earth before our sun explodes, Gold will be just as shiny as it is today.”

Jewelry and Coinage

In 2016 archaeologists in Bulgaria found what they believe to be the world’s oldest gold artifact. This is a small gold bead weighing 15 centigrams and dating back to 4,500 BCE. This is older than gold jewelry found at another ancient site, also in Bulgaria near the city of Varna. Yavor Boyadzhiev, associated professor at the Bulgarian Academy of Science, said, “It’s a really important discovery. It is a tiny piece of Gold but big enough to find its place in history.”

While Gold and other metals were used for barter by careful weighing, the first historian, Herodotus, writes that it was in 600 BCE in Lydia (present-day western Turkey) that the first gold coins were used. The “Lydian Lion” is the oldest coin still preserved and is made of an alloy of Gold and silver (called electrum). The coin is stamped with the head of a lion.

The use of Gold in coins spread rapidly. In the West, Alexander the Great (330 BCE) used gold coins with a stamp of his head to pay his troops, and in the East, the Chinese invented the “Ying Yuan” gold coin. The Romans and Indians continued this trend, and Gold by itself or in combination with silver or other metals became the most sought-after coins. A gold or gold alloyed coin was used for commerce almost up to the present day.

Paper Currencies and the Gold Standard

A dramatic new invention was created in China during the Song Dynasty (AD 960–1279). This was the first paper currency. The paper note promised to pay the holder a certain amount of copper or gold coins. However, it is important to note that paper notes had a “promissory” aspect to them. They promised to pay the holder of the note a certain amount of metal, often gold.

The history of paper currencies has a long and eventful history, but this promissory part remained intact for those countries that wished to protect their currencies’ strength. In theory, at least a person with a paper currency could go to the government and demand the appropriate amount of Gold. Those countries that experimented and abandoned this promise were at the mercy of their government’s excesses. Who was to stop a government from just printing as much paper currency as it wanted, thus leading to inflation?

For the United States, the world’s largest economy, it was important to show strength, both politically and economically but also through their currency the US Dollar. The value of the US Dollar was linked to a fixed amount of Gold. This was called the gold standard.

It took almost 50 years from the start of World War I to the oil shock of the 1970s for the gold standard to get dismantled. In 1971 President Nixon no longer allowed the US Federal Reserve to exchange dollars for Gold and the gold standard that stood behind the US dollar was completed abandoned in 1976.

A Universal Currency and a Hedge Against Inflation – but What Now?

Peter Bernstein, in his excellent book, “The Power of Gold – The History of an Obsession,” writes that, “Discretionary management is the system that the world has chosen to replace the constraint of Gold. All the countries of the world now function with monetary systems convertible into nothing except from one nation’s money into another nation’s money, all of which is costlessly produced with the touch of a computer’s keyboard. We no longer have money that can be tested with a touchstone to determine whether it is the genuine stuff.”

Despite this change, Gold remained a universal currency. It did not change when it passed hands between people from different countries. Gold also played the role of a hedge against inflation. The theory said that if a government-issued too much paper currency, its value would diminish. Inflation would rise, and common people would suffer a loss in their savings. Gold, however, had limited supply, did not rust and remained as pristine as when it was first mined. Gold retained its value and was thus used worldwide as an instrument of saving and a hedge against inflation.

In recent decades, Gold has been abandoned as a key instrument for savings. Equity and debt instruments, real estate, and other commodities play a much more important role. The argument is that most of these instruments provide a yield, and with this growing income, a saver should do better than invest in “just another metal.” Inflation as well is low, despite massive government borrowings. The role of Gold as a major portion of one’s savings seems to have diminished.

We should all keep in mind the following two wise pieces of advice from Bernstein’s book:

  • Robert Mundell, a Nobel prize-winning economist, is quoted as saying, “The main thing we miss today is universal money, a standard of value, a link between the past and the future and the cement linking remote parts of the human race to one another. Gold will [remain] part of the international monetary system in the twentieth century.”
  • “Gold as an end in itself is meaningless. Hoarding does not create wealth. Gold makes sense as a means to an end: to beautify, at adorn, to exchange for what we need and really want.”

© Kaikhushru Taraporevala

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