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Investing in Gold (I)

2010 Jun 9

I will not be the first, and probably also will not be the last, who spoke about the Gold Rush that shakes down the world for the last few years. Just in this time it is a little different than in the days when desired for gold, grabbed a gold shovel with a bucket and started to look for that precious metal, which according to science; even in the universe is relatively so rear. At this time everybody are just too busy to be able to look for gold by themselves. So everyone gets in much simpler way – just buys it.


And why should we buy gold? Probably I asked a stupid question. After all, most are aware that gold is an excellent investment. The price of the gold will go only up and never down – after all this is gold. But sometimes happens, that even the strongest and best professional investors have to change their beliefs. The more buyers become to professionals the greater the likelihood that the beliefs will change. When everyone becomes professionals - this is inevitable. While now in the yellow metal invests not yet every investing person, but it must be recognised, investment in gold is becoming more and more popular.


Can we call this situation a bubble? There are some similarities, but the largest bubbles always are associated with some innovations such as ".com” bubble when people first time encountered such type of companies, and didn’t knew how the market will sooner or later adjust everything to right places. Meanwhile, gold has always been and will be the gold.


Only the price of gold has not always been in the same level. Before the last rise in gold prices a similar behaviour of this metal was three decades ago, in 1977-1980 the gold prices increased by five times, but then quickly lost half the price of the former value, and then maintained in a similar level for two decades. Only in the last decade, the precious metal had jumped up. Only during the last five years, prices increased by 3 times if in Euros, and almost the same in U.S. dollars. Over the last decade in U.S. dollar terms, gold prices increased more than 4 times. Over the past several months, the price of gold fell down shortly, but still much over 1,000 U.S. dollars per ounce range.


The question is what the real value of gold can be? Should be the value of the gold the price that buyers can pay? Unfortunately, but an accurate assessment of the value of gold is almost impossible, because the usual methods for assessing are not suitable: there are no proper substitutes that we could compare; gold does not generate any cash flow; and alchemy unfortunately wasn’t yet successful. All we can say about the price limits of the gold is production costs. The world's largest gold producer Barrick Gold has extraction costs 470 U.S. dollars for one ounce of gold, the second largest producer 380 USD, and the largest Russian gold mining company Polyus Gold – 360 USD. Mentioned figures show that if the price would fall below these limits would be not profitable to extract more gold. Still we cannot say that if prices of gold would go down all gold mining companies would stop their production. Only those that have highest extraction costs would do that, and the others maybe would just stop some investments and work further not in full capacity.

 

Rokas Lukošius

 

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