Why Gold Matters: Everything You Need to Know

Gold. It's shiny, metallic, and melts easily into bars, coins, or jewelry. It doesn't rust, corrode, or decay. Gold is ... well, golden. But why is gold so valuable, both in our mind's eye and in reality as a global store of value and medium of exchange?

Why is silver relegated to a distant second place, and what about poor old copper, which shares many of the same physical attributes as gold? Learn more about the answers to these questions, and much more.

Gold as an Investment

Before jumping on the gold bandwagon, let us first put a damper on the enthusiasm around gold and examine some reasons why investing in gold poses some fundamental issues.

The main problem with gold is that, unlike other commodities such as oil or wheat, it does not get used up or consumed. Once gold is mined, it stays in the world. A barrel of oil, on the other hand, is turned into gas and other products that are expended in your car's gas tank or an airplane's jet engines. Grains are consumed in the food we and our animals eat. Gold, on the other hand, is turned into jewelry, used in art, stored in ingots locked away in vaults, and put to a variety of other uses. Regardless of gold's final destination, its chemical composition is such that the precious metal cannot be used up—it is permanent.

Because of this, the supply-demand argument that can be made for commodities such as oil and grains doesn't hold so well for gold. In other words, the supply will only go up over time, even if demand for the metal dries up.

History Overcomes the Supply Problem

Like no other commodity, gold has held the fascination of human societies since the beginning of recorded time. Empires and kingdoms were built and destroyed over gold and mercantilism. As societies developed, gold was universally accepted as a satisfactory form of payment. In short, history has given gold a power surpassing that of any other commodity on the planet, and that power has never really disappeared.

The U.S. monetary system was based on a gold standard until the 1970s. Proponents of this standard argue that such a monetary system effectively controls the expansion of credit and enforces discipline on lending standards because the amount of credit created is linked to a physical supply of gold. It's hard to argue with that line of thinking after nearly three decades of a credit explosion in the U.S. led to the financial meltdown in the fall of 2008.

From a fundamental perspective, gold is generally viewed as a favorable hedge against inflation. Gold functions as a good store of value against a declining currency.

Investing in Gold

The easiest way to gain exposure to gold is through the stock market, via which you can invest in the shares of gold-mining companies. Investing in gold bullion won't offer the leverage you would get from investing in gold-mining stocks. As the price of gold goes up, miners' higher profit margins can boost earnings exponentially. Suppose a mining company has a profit margin of $200 when the price of gold is $1,000. If the price rises 10%, to $1,100 an ounce, the operating margin of the gold miner goes up to $300—a 50% increase.

Of course, there are other issues to consider with gold-mining stocks, namely political risk (because many operate in developing nations) and the difficulty of maintaining gold production levels.

When investing in ETFs, pay attention to net asset value (NAV), as the purchase price can at times exceed NAV by a wide margin, especially when the markets are optimistic.

A list of gold-mining companies includes Barrick Gold Corp. (ABX.TO), Newmont Corp. (NEM), and Agnico Eagle Mines Ltd. (AEM), among others. Passive investors who want great exposure to the gold miners may consider the VanEck Vectors Gold Miners ETF (GDX), which includes investments in all the major miners.

Alternative Investment Considerations

While gold is a good bet on inflation, it's certainly not the only one. Commodities in general benefit from inflation because they have pricing power. The key consideration when investing in commodity-based businesses is to go for low-cost producers. More conservative investors would also do well to consider inflation-protected securities like Treasury Inflation-Protected Securities, or TIPS. The one thing you don't want is to be sitting idle—in cash, thinking you're doing well—while inflation is eroding the value of your dollar.

Gold Price Performance

The price of gold depends on a complex array of factors. Because gold is priced in dollars, the value of the U.S. currency can have a significant impact on the performance of the precious metal. A strong dollar makes gold more expensive for buyers in other countries, potentially leading to lower gold prices. On the other hand, a weaker dollar makes gold more affordable for international purchasers and may bring increased prices. Since gold is seen as a hedge against inflation, the decline in the value of fiat currencies and the market's expectations surrounding inflation can also affect gold prices.

These factors seem to be evident in the yellow metal's recent price history. Throughout most of 2022, despite soaring levels of inflation, gold prices actually dipped, likely driven lower by sustained strength in the dollar against other currencies. More recently, with inflation remaining stubbornly persistent despite the Federal Reserve's attempts to bring it under control, gold prices have recovered to more than $1,875 per ounce in January 2023, from around $1,656 per ounce in September 2022.

What's to Come

You can't ignore the effect of human psychology when it comes to investing in gold. The precious metal has always been a go-to investment during times of fear and uncertainty, which tend to go hand in hand with economic recessions and depressions. 

In the articles that follow, we examine how and why gold gets its fundamental value, how it's used as a form of money, and which factors subsequently influence its price on the market—from miners to speculators to central banks. We will look at the fundamentals of trading gold and what types of securities or instruments are commonly used to gain exposure to gold investments. We'll look at using gold both as a long-term component of a diversified portfolio and as a short-term day trading asset. We'll look at the benefits of gold but also examine the risks and pitfalls and see if it lives up to the "gold standard."

The Bottom Line

Gold has held a special place in the human imagination since the beginning of recorded time. From an investment perspective, gold is attractive because of its potential to remain strong in difficult financial environments and to hedge against inflationary declines in the value of fiat currencies.

Although the U.S. dollar and other world currencies are no longer pegged to gold—as was the case when many countries operated under the gold standard—the precious metal continues to play an important role in the global economy.