‘It will never go to zero’: Just how safe is it to invest in gold?

It’s generally accepted among the finance world that gold is considered a safe-haven asset. The gains it has made over the past few weeks (one ounce is now worth over $7000) since conflict broke out in the Middle East are a good example of this.

But just how safe is gold? Can it really protect those who hold it from cataclysmic financial events?

To answer these questions, it pays firstly to understand how gold differs from other financial assets. “Unlike almost every other financial asset, gold cannot be created,” says economist Saul Eslake.

“Currency is created by national governments. Bonds are issued by national governments, too, and those governments can default on them or inflate their value away. Shares are created by companies, which can go bankrupt.”

Gold, on the other hand, exists in the world in finite quantities and is not easily destroyed, which is one reason it is widely accepted as a store of wealth.

What also sets gold apart is its intrinsic value. The ancient Egyptians coveted gold for its lustrous appearance and used it both as jewellery and currency. Today, gold is a status symbol which has applications in aerospace, medicine and consumer electronics.

“The price of gold would never fall to zero because people use it for things other than wealth protection and speculation, whereas the price of bitcoin or US government bonds could conceivably collapse to zero,” says Eslake.

In the eye of the beholder

Gold may have value because of its scarcity and physical properties, but another fundamental characteristic works against it, says AMP chief economist Shane Oliver.

“Warren Buffett maintains that gold is impossible to value because it doesn’t produce an income stream, unlike shares that produce profits and dividends. You need to have faith that other people will see the value in it,” he says.

It’s perhaps unsurprising, then, that shares have historically outperformed gold during good economic times. It’s when things go bad that gold can come into its own.

“If you really think the world’s going to hell in a handbasket, stashing a few gold bars under your bed is not irrational.”

Economist Saul Eslake

When stock markets crash, investors’ first response is often to buy the US dollar, which has long been regarded as the world’s reserve currency. But if a financial crisis subsequently develops and the US Federal Reserve begins printing money, thus devaluing its currency, investors retreat to gold.

Holding gold during tumultuous times could theoretically be doubly protective for Australians. That’s because the Aussie dollar usually falls against the US dollar when markets crash, and gold – which is valued in US dollars – often rallies. But gold hasn’t always behaved this way.

“Gold didn’t provide much protection when the dotcom bubble burst, and throughout the recession of the early 1990s and the Asian debt crisis of the late 1990s, gold actually fell in value,” notes Oliver.

Gold and the new world order

Gold has rallied dramatically over the past year, seemingly independent of any shocks to the global financial system. So, what’s going on? Oliver points to the significant acquisition of gold by central banks in China, Russia and elsewhere as one reason.

“Russia has seen its foreign-held reserves of US dollars taken away from it, and other countries worry they might be next, so they have been buying gold, partly as a hedge against that,” he says.

“As well, these countries want to trade among themselves without relying on the US dollar. So, they are increasingly looking for other stable assets to hold and trade.”

There’s also widespread concern that Donald Trump’s interventionist style may affect the Fed’s ability to operate independently and manage inflation.

“Since the return of Trump to the White House, confidence in the US dollar and US Treasury bonds as safe haven assets has eroded because of the erratic and capricious nature of Trump’s economic policymaking,” says Eslake.

Meanwhile, rising public debt levels in the US and Europe have fuelled fears that central banks may soon need to print money to buy some of that debt.

“It’s all those things together,” says Oliver. “It’s countries trying to become more financially independent of the US, it’s worries about high levels of public debt, and it’s consistently elevated geopolitical risk.”

Against this backdrop, it makes sense that investors are looking for safe havens. For now, gold retains its allure.

“Whether it will continue to do so is an open question,” says Eslake. “But if you really think the world’s going to hell in a handbasket, stashing a few gold bars under your bed is not irrational.”

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

Expert tips on how to save, invest and make the most of your money delivered to your inbox every Sunday. Sign up for our Real Money newsletter.