Paper assets such as deposits, bonds, and stocks exist because investors trust the issuing country or company. Low creditworthiness often leads to sluggish trading, and if the issuing entity goes bankrupt, these instruments become worthless. However, gold is found in nature, it is traded based on its intrinsic value, and has no credit risk.
Gold has been a hot topic recently, having climbed to several all-time highs. In our last article, “Expressing the value of gold,” we described the concept of gold pricing. In this article, we shall delve into the differences between gold and paper assets such as deposits, bonds, and stocks.
Paper assets exist because investors trust the issuing country or company. Low creditworthiness often leads to sluggish trading, and if the issuing entity goes bankrupt, these instruments become worthless. However, gold is found in nature, it is traded based on its intrinsic value, and has no credit risk.
Zero credit risk allows gold to dominate the market
Deposits, bonds, or stocks, also known as paper assets, are traded based on the creditworthiness of the issuing country or company. If these defaults, investments may be lost. This is what we know as credit risk. In recent years, many banks have emerged that deal only with electronic transactions, and even government bonds or stocks are no longer issued in paper form.
Gold's existence does not depend on the reputation of any country or company. It is a product of nature and is traded solely based on its value. Therefore, it has no credit risk. The price of precious metal fluctuates constantly, and although sometimes it can fall, it always holds its value in the long run. This is the most significant difference between gold and paper assets.
As an aside, gold does not burn into ashes. In a fire, paper money may turn to ashes, but gold, when melted, can be cooled and restored into bullion for further processing. This is precisely what happened during the Great Hanshin (Kobe) earthquake in January 1995, when a news report showed paper money in a burnt vault turned to ashes while the gold bars melted only to solidify again. This can be seen as a symbol of gold's suitability for wealth preservation.
Gold has no nationality
The foreign exchange departments of financial institutions generally trade gold against other major currencies as a form of non-national currency. So, when market conditions are negative, trading gold as a currency can mitigate the risks of the paper currency and the economy.
Gold is finite
Central banks hold gold for several reasons, one of which is to diversify their reserves. Gold is a physical commodity with intrinsic value, which is tied to its material properties, demand and supply. On the other hand, the amount of paper money, bonds and stocks can be decided and issued at will.
However, gold has a finite stock, so only a limited amount can be used. Even though new gold is produced yearly, mining and smelting require time and money. So, in comparison to the precious metal, currencies are more straightforward.
Gold does not pay interest or dividends
Gold has many advantages compared to paper assets, but has a few downsides. Both deposits and bonds pay interest, and typically, the lower the issuer's credit rating, the higher the interest, which means you can choose high-risk, high-return options. This does not happen with gold. With stocks, you can benefit from price increases, and they also pay dividends based on the company's profit. When the economy of a country or a company develops smoothly, paper assets play an important role as financial products, enabling investors to earn interest or dividends.
In summary, unlike deposits, bonds, and stocks, gold has no credit risk, is a universally recognised non-national currency, and is more suitable for value preservation than paper assets. However, its quantity is limited, the market size is relatively small, and it does not pay interest or dividends. Gold possesses a risk-hedging function that other financial assets cannot compare to.
Gold’s link to the USD
The value of gold is expressed in terms of the exchange rate between 1 ounce of gold and the USD; in other words, how many US dollars it takes to buy 1 ounce of gold. The ounce is the unit of measurement commonly used for precious metals like gold, platinum, silver, and palladium, and 1 ounce equals 31.1035 grams. While dealing with decimals can be cumbersome, it is essential to remember this value if you have an interest in gold. The ounce serves as the fundamental unit for precious metals.
After World War II, the US became the centre of the global economy, and the USD became the benchmark for assessing the value of various currencies. Similarly, the value of gold is measured against the USD. This is why statements like ‘gold is expected to break through $2000’ or ‘gold is projected to drop below $1500’ refer to how much 1 ounce of gold costs in USD. The XAUUSD is traded 24 hours a day worldwide.
Keen to start trading gold?
Gold has recently made news, reaching record highs. In times of volatility, gold is seen as a safe haven asset, thus, investor interest is expected to remain high.
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