In the past, before the advent of fiat money, stable currencies were backed by precious metals like gold, allowing for direct exchange upon demand. This backing provided stability to currencies and instilled confidence in paper money. Over time, we transitioned to pure paper money, and gold became a distinct form of value.
Gold’s value, like fiat money, is derived from its desirability as a means of exchange. However, what sets gold apart is its versatility, as it has industrial uses and is valued for its beauty, much like art. On the other hand, fiat money serves solely as a medium of exchange.
During times of trouble, even the smallest amount of gold becomes more desirable, while traditional money and financial securities are often shunned. This increased demand for gold during crises is one of the main reasons why it is considered a reliable shelter and hedge against economic downturns, both minor and severe.
Wealth needs to be stored securely, and while financial disasters can lead to loss of wealth, it is traditional currency, susceptible to devaluation due to inflation, that is particularly vulnerable. Historical examples, such as Germany’s hyperinflation period, demonstrate the devastating effects of inflation on a currency’s value.
In contrast, gold tends to maintain its value during even the most extreme inflationary periods. Unlike currency, the value of which is tied to inflation, gold remains largely unaffected by inflation, especially on the downside. Thus, gold serves as an excellent hedge not only against general inflation but also against significant inflationary movements, making it one of the most reliable stores of wealth that is highly resistant to inflation.
How Much Should We Worry About These Things?
Today’s economies are managed more effectively compared to the past, and central banks act swiftly to address even minor issues to prevent them from escalating into larger problems, especially hyperinflation.
While it is unlikely that we will return to the double-digit inflation rates of the past, it is essential to remain vigilant about the potential for inflation to grow and be prepared accordingly.
The risk of a well-managed economy plunging into hyperinflation is minuscule, and before major financial disasters occur, smaller-scale disasters often manifest, providing warning signs.
Some concerns revolve around physical disasters possibly triggering such events, but in extreme scenarios like global nuclear wars, considerations of wealth protection may take a back seat to survival.
In the event of economies collapsing during such disasters, trade mechanisms may come to a halt, affecting both currency and gold trading. The value of gold heavily depends on its overall market, more so than currency.
In extreme disaster situations, currency may be more practical for immediate exchange among parties, given its ease of use compared to gold coins or bars, which are not easily divisible into smaller increments.
Holding a significant amount of cash at home may be advantageous for those who are wealthy and concerned about potential disasters, even though it is not an efficient strategy under normal circumstances.
In domestic markets, currency values tend to change gradually, driven by rising prices and the need for higher income to compensate. During major disasters, people will still require a means of exchange, and currency may be more widely accepted than gold in smaller denominations.
While gold may offer limited practical value in protecting against extreme events, some individuals may still choose to hold it for psychological reasons, as a form of security or insurance. Ultimately, these psychological benefits should not be underestimated.
Gold as Protection Against Financial Disasters
The usefulness of gold during times of trouble relies heavily on the functioning of worldwide financial markets. If gold can be traded as usual, it indicates that the crisis is primarily economic in nature, and civilization and governments are less likely to collapse entirely.
During economic crises, gold truly shines as a valuable asset because it remains tradable on markets and is insulated against the turmoil that affects other aspects of the economy. While other elements of the economy, such as currencies, governments, businesses, stock markets, and bonds, may suffer significant losses, gold tends to remain stable and may even increase in value as people seek refuge in it.
A notable example is the financial crisis of 1929, during which the stock market experienced a severe downturn. In contrast, the value of gold doubled over the following decade, demonstrating its resilience during economic upheaval.
It is common to observe a delay in the surge of gold prices after a crisis begins. Investors often need time to assess their losses and fully grasp the reality of their situation before moving toward gold as a safe-haven asset.
The Lag Between Economic Turmoil and Gold
Historical examples have shown that gold’s rise as a safe-haven asset may not immediately coincide with the onset of a crisis. Instead, there might be a delay as investors take time to assess the situation and adjust their portfolios.
The Great Recession and the 1929 financial crisis are prime illustrations of this phenomenon. People tend to be slow to react with their investments, even during crises, which can result in initial fluctuations in the price of gold before it becomes a sought-after safe-haven asset.
This highlights the importance of timing when considering gold as an investment. Waiting for the market to stabilize and showing a clear upward trend may be a more prudent approach than hastily moving into gold at the onset of a crisis. Investing in gold solely as a hedge against uncertain events without a clear strategy may expose investors to unnecessary risks.
Gold’s value is subject to market movements, and its price can fluctuate significantly over time. Unlike stocks, gold does not consistently accumulate value over long periods, which means careful consideration of when and how to invest is crucial.
While gold can indeed be a valuable hedge during difficult economic times, it is crucial to approach gold investing with a view toward its projected direction. Randomly entering positions in gold without a well-reasoned expectation of profit may not be the most effective investment strategy.
Therefore, preparing for a crisis by setting aside a significant portion of wealth solely as a contingency for gold investment may not always be advantageous. It might be wiser to be patient and assess the market during the crisis to determine the best time to invest in gold and seek profit opportunities when they arise.
