Why invest

Gold is a foundation asset within any long term savings or investment portfolio. For centuries, particularly during times of financial stress and the resulting 'flight to quality', investors have sought to protect their capital in assets that offer safer stores of value. A potent wealth preserver, golds stability remains as compelling as ever for todays investor. As one of the few financial assets that do not rely on an issuer's promise to pay, gold offers refuge from widespread default risk. It offers investors insurance against extreme movements in the value of other asset classes. A number of compelling reasons underpin the widespread renewal of interest in gold as an asset class:

Portfolio diversification
Most investment portfolios primarily hold traditional financial assets such as stocks and bonds. Diversifying your portfolio can offer added protection against fluctuations in the value of any single asset or group of assets. Risk factors that may affect the gold price are quite different in nature from those that affect other assets. Statistically, portfolios containing gold are generally more robust and less volatile than those that do not.

Inflation hedge
Market cycles come and go, but over the long term, gold retains its purchasing power. Golds value, in terms of the real goods and services that it can buy, has remained remarkably stable for centuries. In contrast, the purchasing power of many currencies has generally declined, due for the most part to the rising price of goods and services. Hence investors often rely on gold to counter the effects of inflation and currency fluctuations.

Currency hedge
Gold is employed as a hedge against fluctuations in currencies, particularly the US dollar. If the worlds main trading currency appreciates, the dollar gold price generally falls. On the other hand, a fall in the dollar relative to the other main currencies produces a rise in the gold price. For this reason, gold has consistently proved to be one of the most effective assets in protecting against dollar weakness.

Risk management
Gold is significantly less volatile than most commodities and many equity indices. It tends to behave more like a currency. Assets with low volatility will help to reduce overall risk in your portfolio, adding a beneficial effect on expected returns. Gold also helps to manage risk more effectively by protecting against infrequent or unlikely but consequential negative events, often referred to as tail risks.

Demand and supply

The price of gold tracks the shifting balance of supply and demand. Long lead times in gold mining mean production of gold is relatively inelastic, regardless of increases in demand. Thats why the rally in the gold price since 2001 has not engendered a meaningful increase in gold production levels. Demand for gold has shown sustained growth recently, due at least in part to rising income levels in key markets. These supply and demand factors have laid foundations for golds most positive outlook in over a quarter of a century.

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Why invest Portfolio diversification Inflation hedge Currency hedge Risk management Demand and supply Gold for pension funds How to invest Where to invest FAQs Glossary

Portfolio diversification
Asset allocation is a vital aspect of any investment strategy. Balancing asset classes of different correlations can significantly enhance returns whilst reducing risk. Many investors believe their portfolios are sufficiently diversified. However, the majority of investment strategies focus primarily on only a few asset classes stocks, bonds and cash. Such portfolios may be vulnerable when these asset classes react to market conditions in a similar fashion. To counter this effect, many investors now seek more effective diversification by incorporating alternative investments, such as commodities, into their portfolio. Gold has shown very strong returns over recent years. Still, its most valuable contribution to a portfolio lies in the fact that it is not correlated with most other assets (see chart below). This independence comes from the fact that golds price is not driven by the same factors that drive the performance of other asset classes. For more information, you can download all the relevant data and charts covering a range of countries on our investment statistics page.

5-year weekly return correlation on key assets and gold (US$) - click to enlarge

The sources of demand for gold are far more diverse - both geographically and sectorally - than those of many other assets. This helps to explain the independence of the gold price. It also explains why identifiable demand has remained robust despite a rally thats spanned several years. Between 2000 and 2009, the value of global gold demand increased by 272%. Moreover, most spending on gold is discretionary. 63% of total identifiable appetite over the five years to December 2009 came from the jewellery sector. A further 25% came from investment, while technological applications account for 12% . This market structure is unusual for commodities. Demand is usually driven by non-discretionary spending and is therefore differently exposed to the vagaries of the economic cycle. Gold has seen recent growth in investment demand, at both the institutional and retail levels. This has further broadened the precious metals demand base, with tonnage demand increasing 119% over the last five years (to year-end 2009). A stronger investment demand can act as a counterbalance should recessionary pressures dampen consumer spending on jewellery. Independent studies have shown that gold offers enhanced opportunities for diversification, relative to most other alternative assets. While traditional diversifiers often fail during times of market instability, even a small allocation to gold can significantly improve the consistency of portfolio performance. Particularly appealing to many investors is the fact that this protection applies during both stable and unstable financial periods.

Inflation hedge
Investors around the world recognise gold as one of the most reliable hedges against inflation. The value of gold, in terms of the real goods and services it can buy, has remained largely stable for decades, if not centuries. In 1900, the gold price was $20.67/oz. And, in the five years to end-December 2009, the price of gold averaged around $717.

Prices in 2010 have consistently remained well above the $1000 level and, indexed to 1900 prices, gold has held its value better than any other currency. Golds real price has endured a century characterised by sweeping change, inflation and repeated geopolitical shocks. Despite all challenges, it has retained its purchasing power. In contrast, the real value of most currencies has generally declined.

Currencies in terms of gold - click to enlarge

Updated annually; last updated 16th November 2010 A growing body of research supports gold's reputation as a protector of wealth against the ravages of inflation. Numerous economists have demonstrated that, over the long term, through both inflationary and deflationary periods, gold has consistently maintained its purchasing power. Of course experience has shown that gold can deviate from its long-run inflation-hedge price. During a sustained buoyant period, as is currently the case, it can even offer opportunities for impressive returns.

Currency hedge

Investors have long regarded gold as a good protection against depreciation in a currency's value. The defensive properties apply both internally (i.e. against inflation) and externally (against other currencies). In the latter case, gold is widely considered to be a particularly effective hedge against fluctuations in the world's main trading currency, the US dollar.

Gold and the trade-weighted $ 1993-2010 - click to enlarge

Research undertaken in 2004 examined the relationship between the gold price and the exchange rate of various currencies against the US dollar from 1971 to June 2002. The resulting data provided firm evidence of gold's effectiveness as a dollar hedge. The research showed the gold price to be negatively correlated with the US dollar, and to have been consistently so over time and across exchange rates. Analysts established that throughout this period (1971-2002) of considerable economic turbulence, gold offered investors consistently strong protection against instability and exchange rate fluctuations. Concerns remain regarding the fragility of most of the worlds major currencies. Many investors and policy makers are again considering golds role as a monetary asset and currency. This attention has supported golds multi-year appreciation in price.

Risk management
Financial asset classes and instruments usually carry three main types of risk. Credit risk: the risk that a debtor will not pay Liquidity risk: the risk that the asset cannot be sold as a buyer cannot be found Market risk: the risk that the price will fall due to a change in market conditions Gold is unique in that it does not carry a credit risk. Gold is no one's liability. When you invest in gold, theres no risk that a coupon or a redemption payment will not be made, as for a bond. Theres no chance that a company will go out of business, as with an equity. Unlike a currency, the economic policies of the issuing country cannot affect the value of gold, nor can inflation in that country undermine it. Gold benefits from demand among a wide range of buyers - from the jewellery sector to financial institutions, to the technology sector and manufacturers of industrial products and medicines. A wide range of investment channels is available, including coins and bars, jewellery, futures and options, exchange-traded funds, certificates and structured products. Liquidity risk: Worldwide markets trade gold 24 hours a day. The gold market is deep and liquid, as demonstrated by the fact that gold can trade at narrower spreads and more rapidly than most diversifiers or even mainstream investments. Gold, like all financial assets, is subject to market risk. However, it tends to have low correlations to most assets usually held by institutional and individual investors, which significantly enhances gold's attractiveness as a portfolio diversifier.Research published in October 2010, demonstrated that gold can help to reduce the potential loss suffered when infrequent or unlikely but consequential negative events, often referred to as tail risks, occur. Specifically, even a small allocation to gold, ranging between 2.5% and 9.0%, can decrease the Value at Risk (VaR). Volatility is a good indicator of market risk, measuring the dispersion of returns for a given security or market index. The more volatile an asset, usually the riskier it is. The gold price is typically less volatile than other commodity prices. This is because of the depth and liquidity of the gold market, which is supported by the availability of large above-ground stocks of gold. Gold is virtually indestructible, which means nearly all the gold ever mined still exists today. Much of it is in near market form, meaning sudden excess demand for gold can usually be satisfied with relative ease. Adding to price stability, gold is mined all over the world. Unlike many other commodities, this geographical diversity reduces the chance of supply shocks from any specific country or region impacting heavily on golds price. Consequently, gold is generally less volatile than heavily traded blue-chip stock market indices such as the FTSE 100 or the S&P 500.

S & P and Gold: 22-day average. volatility - 1990-2010 - click to enlarge

Demand and supply

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Gold - The supply side

The demand and supply dynamics of the gold market underpins the precious metals extensive appeal and functionality, including its characteristics as an investment vehicle.

Demand flows, 5-year average (Q4'05 to Q3'10) - click to enlarge

Supply flows, 5-year average (Q4'05 to Q3'10) - click to enlarge

Above-ground stocks, end 2009 (total: 165,600 tonnes) - click to enlarge

Demand
Demand for gold is widely dispersed around the world. East Asia, the Indian sub-continent and the Middle East accounted for approximately 70% of world demand in 2009. India, Greater China (China and Hong Kong), US, Turkey and Saudi Arabia represented over half of world demand. A different set of socio-economic and cultural incentives drives each market, creating a diverse range of factors influencing demand. Rapid demographic and other socioeconomic changes in many of the key consuming nations are also likely to produce new patterns of demand in the foreseeable future. Read more in our detailed briefing note about Gold Demand Trends, which also includes commentary on supply.

Jewellery demand
Jewellery consistently accounts for over two-thirds of gold demand. In the 12 months to December 2009, appetite for jewellery amounted to around US$55 billion, making it one of the world's largest categories of consumer goods. India is the largest consumer in volume terms, accounting for 27% of demand in 2009. Indian gold demand is supported by cultural and religious traditions which are not directly linked to global economic trends. Find out more in our special reports The role of gold in India and India Gold Report - India: Heart of Gold - Revival. The 2007-2009 financial crisis had a significant negative impact on consumer spending. This has resulted in the reduced volume of jewellery sales, particularly in western markets, with the United States being hardest hit. However, jewellery demand in India and Asia has since been recovering whilst in China growth in jewellery consumption has been continuous. Jewellery demand is driven by a combination of affordability and desirability by consumers. It rises during periods of price stability or gradually rising prices, and then declines in periods of price volatility. A steadily rising price reinforces the inherent value of gold jewellery, an intrinsic part of its desirability. Several countries, including China and India, offer clear and considerable potential for future growth.

Investment demand

A significant portion of investment demand is transacted in the over-the-counter market, therefore not easily measurable. However, theres no doubt that investment demand in gold has increased considerably in recent years. Since 2003, investment has represented the strongest source of growth in demand. The last five years to the end of 2009 saw an increase in value terms of around 119%. In 2009 alone, investment attracted net inflows of approximately US$41bn. Numerous factors motivate people and institutions to seek gold investments. The positive price outlook is underpinned by expectations that growth in demand will continue to outstrip that of supply. Of the key drivers behind investor demand, one common thread emerges: all are rooted in gold's abilities to insure against instability and protect against risk. Gold investment can take many forms. Some investors choose to combine two or more of these different forms for flexibility. The distinction between buying physical gold and gaining exposure to movements in the gold price is not always clear. This is especially true since it is possible to invest in bullion without actually taking physical delivery. The growth in investment demand has sparked numerous innovations in gold investment, ranging from online bullion sales to gold ETFs. There are now a wide variety of investment products to suit both the private and institutional investor. Read more about how to invest.

Technological demand
Industrial, medical and dental technology accounts for around 12% of gold demand (an annual average of over 434 tonnes from 2005 to 2009). Gold offers high thermal and electrical conductivity, along with outstanding resistance to corrosion. This explains why over half of all industrial demand arises from its use in electrical components. Gold's use in medical applications has a long history, reaching back to ancient Egypt. Today, various biomedical applications make use of its numerous attributes, including bio-compatibility as well as resistance to bacterial colonization and corrosion. Recent research has uncovered a number of new practical uses for gold, including its function as a catalyst in fuel cells, as well as chemical processing and pollution control. The potential to use nanoparticles of gold in advanced electronics, glazing coatings, and cancer treatments offers promising new areas of scientific research. Find out more about the technological applications of gold. Read the latest on the industrial markets and growing uses for gold.

Supply Mine production

Gold is produced from mines on every continent except Antarctica, where mining is prohibited. There are several hundred gold mines operating worldwide ranging in scale from minor to enormous. This figure doesnt include mining at the very small-scale, artisanal and often unofficial level. Today, the overall level of global mine production is relatively stable. Supply hasaveraged approximately 2,497 tonnes per year over the last several years. The stability of production comes from the fact that when new mines are developed, theyre mostly serving to replace current production, rather than expanding global production levels. Gold production does experience comparatively long lead times, with new mines taking up to 10 years to come on stream. That means mining output is relatively inelastic, unable to respond quickly to a change in price outlook. Even

a sustained price rally, as experienced by gold over the last seven years, doesnt translate easily into increased production.

Recycled gold
While gold mine production is relatively inelastic, recycled gold ensures there is a potential source of easily traded supply when needed. This helps to cater for an increase in demand and keep the gold price stable. The high value of gold makes recovery economically viable, as long as the precious metal is in a form thats capable of being extracted, melted down, re-refined and reused. Between 2005 and 2009, recycled gold contributed an average 32% to annual supply flows.

Central banks 1) Central banks

Central banks and multinational organisations (such as the International Monetary Fund) currently hold just under one-fifth of global above-ground stocks of gold as reserve assets (amounting to around 30,500 tonnes, dispersed across 110 organisations). On average, governments hold around 10% of their official reserves as gold, although the proportion varies country-by-country. While the sector as a whole has typically been a net seller since 1989, there has been a seismic shift in central bank attitudes toward gold. For two decades, the official sector was a net seller of a substantial quantity of gold to the private sector markets around the world. That period came to an end during 2009. As a legacy of the gold standard, the advanced economies in Western Europe and North America hold on average over 50% of their external reserves in gold. The appetite for sales among these countries has dwindled away to practically zero. Emerging market countries typically hold less than 10% of their reserves in gold, but their economies are growing very rapidly; increasingly these countries are being identified as buyers of significant quantities of gold for their reserves. Since 1999, the bulk of sales from central banks have been regulated by the Central Bank Gold Agreement/CBGAswhich have stabilised sales from 15 of the world's biggest holders of gold. Significantly, gold sales from official sector sources have been diminishing in recent years. Net central bank sales amounted to just 41 tonnes in 2009. For more on Central Bank gold holdings. For quarterly Reserve Asset statistics.

Gold production
The process of producing gold can be divided into six main phases: finding the ore body creating access to the ore body removing the ore by mining or breaking the ore body transporting the mined material from the mining face to the plants for treatment processing refining This basic process applies to both underground and surface operations. The world's principal gold refineries are based near major mining centres or precious metals processing centres worldwide. In terms of capacity, the largest is the Rand Refinery in Germiston, South Africa. On the basis of output, the largest is the Johnson Matthey refinery in Salt Lake City, US. Rather than buying gold and then selling it onto the market later, the refiner typically takes a fee from the miner.

Once refined, the bullion bars (with a purity of 99.5% or higher) are sold to bullion dealers. These dealers then trade with jewellery or electronics manufacturers or investors. Avoiding large bilateral contracts between miner and fabricator, this dealer-based bullion market lies at the heart of the supply-demand cycle. It facilitates free flow of the precious metal, and underpins the free market for gold. You can visit the Gold Bars Worldwide website for a wealth of information on the international gold bar market.