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Still lots of reasons to hold gold

The market price of gold might have fallen during the year but hoarding of the precious metal by individuals and central banks is approaching record levels.

In trading terms, it has been a tough year for the yellow metal. The price has fallen 28 per cent in 12 months. But the fundamentals, characteristics and attractions of gold are undiminished because we are in times of extreme intervention by governments, the outcome of which is completely unknown.

The first rule of investment is preservation of capital. The second is to search for gains or income that fits with your appetite for risk.

Gold has been the insurance of choice for thousands of years to satisfy the first rule, despite the fact that it generates no income and incurs costs for storage.

For other ways of protecting wealth, such as a bank account or government bonds, the rates of interest have been destroyed by monetary stimulus.

With negative rates on some of the safest bonds in the world, such as short-dated Swiss government bonds, investors now have to pay to lend Switzerland money and, once adjusting for inflation, investors are also paying the bank to hold their cash.

Gresham’s Law

Against this backdrop, it seems odd that the price of gold has fallen so sharply. There are several reasons for this. Like all markets, over-exuberance had pushed the price higher than the fundamentals could support. At the same time, gold’s big rival as a store of value, the US dollar, has recovered as strong economic growth supports the world’s reserve currency.

One of the most interesting reasons that can be linked to the falling gold price is found in “Gresham’s Law” that “bad money drives out good”.

The Tudor financier, Thomas Gresham, found that: “When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.”

Source The Age Money

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