What Drives Gold

What Drives Gold

The value of gold is the price of gold

You will have noticed the stand out performance of South African gold equities since the start of the year and perhaps wondered why they are doing well this time. Gold equities are in fact (poor) derivatives of the metal itself, and so it is useful to ask the same question as it relates to directly investing in gold. No one, no rational person at least, goes to bed thinking about gold, purely on its investment merits, and then gets up it in the morning and buys or sells it. The appeal of gold, and its derivative, gold equities, lie totally outside of the metal itself. The value of gold is the price of gold. The price of gold is inversely related to: (i) the real interest rate on paper backed by the credibility of the government (Treasury bills and bonds), and (ii) the expected return of high quality equities.

Protecting the purchasing power of savings drives money flows

Investing, rationally speaking is the act of protecting the purchasing power of one’s savings from erosion by inflation. Strictly speaking, the idea is to not only keep up with inflation, but earn a return above inflation. An instrument that keeps up with inflation is a store of value while one whose returns surpass inflation creates value. The latter, known as a productive asset, is clearly a superior hedge against inflation than the former.

A productive asset derives its value from its ability to serve the evolving needs of its customers while creating shareholder value. The longer it does this, the higher its quality. To illustrate, the value of treasury bills and bonds are based on the full faith and credit of the government that issued them. To the extent that investors are confident that both fiscal and monetary policy will not erode the value of income earned from government instruments or artificially inflating the value of those instruments, their faith in the creditworthiness of the government will rise.

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