Introduction

Commodities trading is a significant component of the global financial markets. Unlike securities, commodities trading is available on a futures market such as the Chicago Mercantile Exchange. A commodity could be an agricultural product, a metal, or a raw material that traders can buy and sell. In this article, we highlight gold, which is the most commonly traded commodity in the futures market.

The Gold market (both the primary and the Gold futures market) is a popular destination for value traders. Why value traders? The market has shown the capability to tend upwards in the long-term. For instance, over the past three years, the price of the yellow metal has gained 45.72% to $1,771.50 per ounce

Gold price July 2017 - July 2020

Figure 1: Gold price July 2017 – July 2020

Extending the gold price trend to cover a period of over the past 50 years, investors can realize a strong long-term direction. In January 1970, one ounce of gold cost $35.17. Fast forward, the same ounce is worth $1,771.50. In the 50 years, the value of one ounce of gold grew 4,937%. Look at it this way; if you bought $100 worth of gold in 1970, your investment would be worth $493,696. From the foregoing, gold is the best asset for long-term investors.

A Historical Perspective of Gold

As has been shown above, the value of gold has grown immensely over the past five decades. Gold’s price chart for this period shows something that every value trader desires, tremendous long-term growth! Gold’s value spikes during periods of economic recession, but it never pulls back to previous levels after the recession passes.

Looking at two significant periods of recession over the past 50 years, one identifies the exciting phenomenon. On February 9, 1979, one ounce of gold cost $246.75. A year later, the US sunk into a deep recession caused by the Federal Reserve’s contractionary monetary policy. On January 16, 1980, the Gold price shot up by 208% to $760 per ounce. When the economy stabilized, the Gold price declined but never touched the previous levels. The lowest point came on January 3, 1982, at $320.35, about 30% above the 1979 value.

Gold price Jan 1970 - July 2020

Figure 2: Gold price Jan 1970 – July 2020

Similar behavior was apparent during the Great Recession. Before the recession set in October 2008, one ounce of gold fetched $720. As the recession deepened in September 2011, the Gold price climbed to historical highs of $1,794. The global economy stabilized and reached a peak of stabilization in 2015. In November 2015, the Gold price was at $1,088.90. Still, this was about 51% higher than the pre-recession era.  

Because of its value, gold is a pricey possession. That means countries with the most significant Gold deposits, as well as the miners, have great wealth. Countries like Australia, Russia, South Africa, and the United States have the largest Gold deposits.

To be useful, these reserves need mining. The top five biggest gold miners in the world are Newmont Goldcorp (NYSE: NEM), Barrick Gold Corporation (NYSE: GOLD), AngloGold Ashanti Limited (NYSE: AU), Kinross Gold Corporation (NYSE: KGC), and Freeport-McMoRan Inc. (NYSE: FCX).

World mine reserves of gold as of 2019, by country (in metric tons)

Figure 3: World mine reserves of gold as of 2019, by country (in metric tons)

Why is gold a safe asset?

To be just, we must begin this section by defining what a safe asset is. Otherwise called haven assets, safe assets are those whose values remain intact or even increase during a period of the economic storm. While other assets’ value plunges, the value of safe assets declines by insignificant amounts, if there must be a decline. Safe-haven assets are critical to investors because they help to preserve the value of their wealth. Gold is the best example of a safe haven asset.

How does gold behave during periods of market turmoil? To answer this question, let us consider Figure 2. The figure shows the price movement of one ounce of gold since the elimination of the Gold standard in 1971. In the 50 years between 1970 and 2020, there have been two significant periods of market turmoil, 1980-82 and 2008-2011. In these periods, the price of gold jumped to historic highs. Why is that?

In a market turmoil, investors rush to protect their principal. That means taking their money out of risky assets – assets whose value plummets immensely in a downturn. Gold seems like the only asset investors think of because the other safe-haven assets such as the US dollar and US government debt offer little assurances of stability. Unlike other safe havens, gold is a real asset, which means it is not one person’s asset and another person’s liability like US government debt. 

Further, gold is an excellent hedge against inflation. Inflation is an asset whose value remains constant or increases over time. Regular currency like the US dollar, for instance, cannot be an inflation hedge because its purchasing power falls with time. Contrarily, the yellow metal has held or increased its value over time, except for the period between 1980 and 2001.

Gold vs. US Dollar 

Besides Gold, US Treasuries, cash, and utility stocks, the US dollar is the other safe-haven asset. In comparison to gold, however, gold seems a better alternative. Gold is a better safe haven than the greenback because it is a real asset, which means it has intrinsic value. Other than government assurance that the greenback is legal, nothing else backs the currency.

In addition to being a safe haven, gold is an inflation hedge. If one had bought one ounce of gold in 2000, it would be worth 556% more today. In the same period, the purchasing power of the US dollar has grown by just 11%. And this is after a massive decline that began in 2002, reached the bottom of the trough in 2011, the same year that gold hit historic highs.   

Gold Prices and US Dollar Correlation, 2000 - 2020 

Figure 4: Gold Prices and US Dollar Correlation, 2000 – 2020

How can one invest in gold?

From the foregoing, gold looks like an asset that every investor must hold. The development of capital markets today has made it possible to invest in gold without having to own physical bullion. Numerous financial instruments exist through which investors can get exposure to precious metal trading online. They are:

Gold stocks

Gold mining companies are the first beneficiaries of a Gold Rush during market turmoil. It is because the higher Gold price implies improved profits. During the Great Recession, for example, Gold stocks experienced the highest price jump in history. One can get a better view of this remarkable event by observing the NYSE Arca Gold BUGS Index. It is the most-watched Gold index in the world. 

HUI Gold Index

Figure 5: HUI Gold Index

In August 2011, the HUI Gold index touched the highest level ever in its history at 598.32. It was after a steady climb that started in late 2001. The HUI Gold Index comprises large-cap stocks such as Barrick Gold, AngloGold Ashanti Ltd, Newmont Goldcorp, Kinross, and more. In total, HUI has 14 Gold stocks.

Gold futures

The futures market provides an excellent opportunity for investors to speculate on the price of gold without having to deliver the commodity physically. Futures contracts allow investors to benefit from the difference between the strike price and the spot price. For example, one could buy COMEX Gold futures and get access to the Gold market easily. Other avenues for investing in gold include buying exchange-traded funds such as Granite Shares Gold Trust (BAR). 

The best time to buy gold is when the economy is booming. At this time, the risk appetite of many investors is high, and they prefer riskier assets. Consequently, the offloading of yellow metal leads to lower prices. In Figure 1, notice that Gold price remained depressed between 1980 and 2001 because of a generally booming global economy. 

Conclusion

A financial market is a volatile place where investors are continually shuffling between safe-haven assets and risky assets. For all this, the idea is to maximize profits and to minimize risks. Gold happens to be one of the most sought after safe-haven assets for two reasons. First, gold has intrinsic value and, secondly; the metal’s value increases over time. As such, it becomes a great asset to hedge against inflation. Compared to the US dollar, gold has risen immensely over the past 20 years by 556% compared to the greenback’s 11%. Interested investors can get exposure to the yellow metal by buying Gold stocks, Gold futures, and Gold ETFs.