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Why Gold is Money: A Periodic Perspective

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Why Gold is Money: A Periodic Perspective

Why Gold is Money

The economist John Maynard Keynes famously called gold a “barbarous relic”, suggesting that its usefulness as money is an artifact of the past. In an era filled with cashless transactions and hundreds of cryptocurrencies, this statement seems truer today than in Keynes’ time.

However, gold also possesses elemental properties that has made it an ideal metal for money throughout history.

Sanat Kumar, a chemical engineer from Columbia University, broke down the periodic table to show why gold has been used as a monetary metal for thousands of years.

The Periodic Table

The periodic table organizes 118 elements in rows by increasing atomic number (periods) and columns (groups) with similar electron configurations.

Just as in today’s animation, let’s apply the process of elimination to the periodic table to see why gold is money:

  • Gases and Liquids
    Noble gases (such as argon and helium), as well as elements such as hydrogen, nitrogen, oxygen, fluorine and chlorine are gaseous at room temperature and standard pressure. Meanwhile, mercury and bromine are liquids. As a form of money, these are implausible and impractical.
  • Lanthanides and Actinides
    Next, lanthanides and actinides are both generally elements that can decay and become radioactive. If you were to carry these around in your pocket they could irradiate or poison you.
  • Alkali and Alkaline-Earth Metals
    Alkali and alkaline earth metals are located on the left-hand side of the periodic table, and are highly reactive at standard pressure and room temperature. Some can even burst into flames.
  • Transition, Post Transition Metals, and Metalloids
    There are about 30 elements that are solid, nonflammable, and nontoxic. For an element to be used as money it needs to be rare, but not too rare. Nickel and copper, for example, are found throughout the Earth’s crust in relative abundance.
  • Super Rare and Synthetic Elements
    Osmium only exists in the Earth’s crust from meteorites. Meanwhile, synthetic elements such as rutherfordium and nihonium must be created in a laboratory.

Once the above elements are eliminated, there are only five precious metals left: platinum, palladium, rhodium, silver and gold. People have used silver as money, but it tarnishes over time. Rhodium and palladium are more recent discoveries, with limited historical uses.

Platinum and gold are the remaining elements. Platinum’s extremely high melting point would require a furnace of the Gods to melt back in ancient times, making it impractical. This leaves us with gold. It melts at a lower temperature and is malleable, making it easy to work with.

Gold as Money

Gold does not dissipate into the atmosphere, it does not burst into flames, and it does not poison or irradiate the holder. It is rare enough to make it difficult to overproduce and malleable to mint into coins, bars, and bricks. Civilizations have consistently used gold as a material of value.

Perhaps modern societies would be well-served by looking at the properties of gold, to see why it has served as money for millennia, especially when someone’s wealth could disappear in a click.

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Purchasing Power of the U.S. Dollar Over Time

$1 in 1913 had the same purchasing power as $26 in 2020. This chart shows how the purchasing power of the dollar has changed over time.

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purchasing power of the dollar

What is Purchasing Power?

The purchasing power of a currency is the amount of goods and services that can be bought with one unit of the currency.

For example, one U.S. dollar could buy 10 bottles of beer in 1933. Today, it’s the cost of a small McDonald’s coffee. In other words, the purchasing power of the dollar—its value in terms of what it can buy—has decreased over time as price levels have risen.

Tracking the Purchasing Power of the Dollar

In 1913, the Federal Reserve Act granted Federal Reserve banks the ability to manage the money supply in order to ensure economic stability. Back then, a dollar could buy 30 Hershey’s chocolate bars.

As more dollars came into circulation, average prices of goods and services increased while the purchasing power of the dollar fell. By 1929, the value of the Consumer Price Index (CPI) was 73% higher than in 1913, but a dollar was now enough only for 10 rolls of toilet paper.

Year EventPurchasing Power of $1What a Dollar Buys
1913Creation of the Federal Reserve System$26.1430 Hershey’s chocolate bars
1929Stock market crash$15.1410 rolls of toilet paper
1933Gold possession criminalized$19.9110 bottles of beer
1944Bretton Woods agreement$14.7120 bottles of Coca-Cola
1953End of the Korean War$9.6910 bags of pretzels
1964Escalation of the Vietnam War$8.351 drive-in movie ticket
1971End of the gold standard$6.3917 oranges
1987"Black Monday" stock market crash$2.282 boxes of crayons
1997Asian financial crisis$1.614 grapefruits
2008Global Financial crisis$1.202 lemons
2020COVID-19 pandemic$1.001 McDonald’s coffee

Between 1929-1933, the purchasing power of the dollar actually increased due to deflation and a 31% contraction in money supply before eventually declining again. Fast forward to 1944 and the U.S. dollar, fixed to gold at a rate of $35/oz, became the world’s reserve currency under the Bretton Woods agreement.

Meanwhile, the U.S. increased its money supply in order to finance the deficits of World War II followed by the Korean war and the Vietnam war. Hence, the buying power of the dollar reduced from 20 bottles of Coca-Cola in 1944 to a drive-in movie ticket in 1964.

By the late 1960s, the number of dollars in circulation was too high to be backed by U.S. gold reserves. President Nixon ceased direct convertibility of U.S. dollars to gold in 1971. This ended both the gold standard and the limit on the amount of currency that could be printed.

More Dollars in the System

Money supply (M2) in the U.S. has skyrocketed over the last two decades, up from $4.6 trillion in 2000 to $19.5 trillion in 2021.

The effects of the rise in money supply were amplified by the financial crisis of 2008 and more recently by the COVID-19 pandemic. In fact, around 20% of all U.S. dollars in the money supply, $3.4 trillion, were created in 2020 alone.

How will the purchasing power of the dollar evolve going forward?

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Getting Gold Exposure: Bullion vs. ETFs vs. Mining Stocks

There are various investment methods to get gold exposure. Whether it’s gold bullion, ETFs, or mining stocks, which one works best for you?

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How to Get Gold Exposure in Your Portfolio, Explained

A lot of talking heads say, “Buy gold!” but don’t really explain exactly how to buy gold or get exposure to the precious metal.

There are options when it comes to getting exposure to the precious metal, and each one has upsides and downsides worth being mindful of.

Whether you’re interested in holding physical gold in a safe storage space or simply want to add some gold exposure to your investment portfolio, this infographic shows you the differences between gold bullion, gold ETFs, and gold mining stocks.

What to Consider Before Investing in Gold

There are some key considerations to be aware of before you begin investing.

While below are some of the main factors to keep in mind as you pick a gold investment method, be sure to research each method and its properties thoroughly before investing.

Downside and Volatility Risk

The first consideration for any kind of investment should always be how much drawdown you’re willing to stomach before pulling your money out.

When the COVID-19 pandemic resulted in a price drop across the board for just about every kind of asset, the price of physical gold and gold-backed ETFs held up very differently compared to individual gold mining stocks and gold mining indices.

Case Study: Gold vs. Mining Stocks Drawdown and Returns

AssetDrawdown from March high to March lowReturns from March low to 2020 high
Spot gold and gold ETFs-14.8%42.9%
Barrick Gold Corporation-42.1%146.8%
Gold Miners ETF (GDX)-46.0%182.9%
Junior Gold Miners ETF (GDXJ)-52.7%237.9%

While physical gold and bullion ETFs (which track gold’s price movements) tend to be more resilient during market downturns, they also offer less upside compared to gold mining stocks and indices during bull markets.

Junior miners or exploration companies offer the greatest volatility and potential upside, but carry the highest risk. When investing in any mining company, concrete results from their planning and drilling along with efficient execution in setting up projects and production will best determine the stock’s valuation.

Active vs. Passive Management

Some investors like to actively manage their investments while others prefer a more passive “set and forget” approach.

Each approach has its merits, however, gold ETFs and mining stocks are better suited for more active investors, while shipping and transport costs for physical gold can add up if buying and selling frequently.

Determine whether you’re going to be actively managing your gold exposure or if you’re going to be letting your investment sit for a while. This way you can determine the best method to reduce fees and commissions.

Three Types of Gold Exposure: Pros and Cons

Now, let’s dive into the three main types of gold exposure: gold bullion, gold ETFs, and gold mining stocks and ETFs.

1. Gold Bullion

If you’re looking to purchase physical gold in the form of bullion, there are a lot of considerations to keep in mind. These range from the various fees you’ll pay to where and how you’ll be storing and protecting your gold.

Many bullion dealers offer storage as a service, reducing shipping costs and the extra work of finding somewhere secure to keep your gold.

Fixed Position Sizes and Liquidity

When buying gold bullion it’s important to remember that you are buying coins, bars, or ingots of gold. This means that if you’re looking to sell off half of your gold position but only have a single 1oz gold coin, you won’t be able to!

Due to this, gold bullion might not be the best option for those interested in actively managing their exposure or for those with smaller amounts of capital.

Buying and Selling Commissions

Just about every gold dealer will charge commissions on any buying or selling, which are typically <1% of the value of the order with lower commissions for larger volumes. Some dealers include their commissions as a premium directly onto their prices.

Storage Costs

Storing gold bullion with gold dealers or storage services will incur yearly storage costs that are typically a percentage of your holdings.

While some storage providers have low percentages, they will often have minimum monthly or yearly storage fees. For investors purchasing small amounts of gold it’s important to not let these fees eat up too much of your investment.

  • Fees range from 0.12% to 1.5% annually, with some storage services providing fee discounts for larger volumes of gold
  • While purchases of investment-grade bullion are tax-exempt, taxes are charged on storage fees.

Reputable gold storage services offer full insurance coverage on your bullion stored with them and will keep your gold physically separate from the company’s gold and off the company balance sheet. Some will even provide customers extra peace of mind with pictures of their bullion, typically for an additional cost.

Withdrawal Commissions and Shipping

If you’ve been storing your gold with a dealer but want it closer to home, you’ll have to pay withdrawal commissions along with shipping costs. Some dealers charge a flat rate per bullion or withdrawal, while others charge a percentage of your holdings.

If you’re having bullion sent to you without storing it at the dealer, you’ll just pay for shipping and insurance. These are typically flat fees along with a percentage of the dollar value of your order (ranging from 0.4% to 7.5% depending on the amount and types of bullion).

Before holding your gold privately it’s important to know:

  • Privately held gold is sometimes not fully trusted when sold back to bullion markets, and can lose some of its value.
  • Privately held gold is usually less physically safe compared to gold in a vault, and is almost always more expensive to insure.

2. Gold ETFs

Exchange-traded funds (ETFs) are a more approachable option to get exposure to gold for those with some experience purchasing shares using online brokers and exchanges.

Gold ETFs enable investors to have exposure to gold’s price while avoiding storage, shipping, and insurance fees. There are also fewer liquidity bottlenecks and tighter spreads with gold ETFs compared to gold bullion.

When buying gold ETFs it is important to remember that in most cases, you never actually own any physical gold. Even though these funds are backed by physical gold, you cannot redeem your shares in exchange for gold.

  • Buying and Selling Commissions: When buying or selling shares of an ETF you’ll likely pay commissions. These commissions are decided by the brokerages and are typically below $10 per buy and sell order, with some brokerages offering commission-free trading to cut costs for active traders.
  • Expense Ratios: Similar to storage fees on gold bullion kept in a vault, gold ETFs charge a yearly expense ratio to cover the costs of management and operations. Expense ratios are typically quite low, ranging from 0.17% to 0.75%, and are taken directly from your investment.

3. Gold Mining Stocks and ETFs

Gold mining stocks and mining ETFs are the most distant from physical gold, and offer exposure to the operating profits, losses, or even discoveries of mining or exploration companies.

Mining ETFs (like the GDX and GDXJ) are a basket of mining stocks for purchase as a single share, helping spread out the operational and concentration risk of investing in a single mining company. Mining ETFs are typically less volatile than individual mining stocks, but can still offer increased returns compared to gold bullion and gold ETFs.

Similar to gold ETFs, mining stocks and mining ETFs have:

  • Buying and selling commissions decided by your online brokerage
  • Annual expense ratios for mining ETFs
  • Potential for dividends depending on the individual mining stock

If buying individual gold stocks, it is important to know that the prospects of any one company can differ incredibly. For this reason, it’s crucial to invest in quality companies, and to have an understanding at factors at play such as management competence, jurisdiction, or project quality and economics.

Find a Gold Investment Method that Works Best for You

Be aware that the methods discussed in this article aren’t the only ways to invest in gold.

If you’re willing to learn a bit more about contract structures and more complex fee structures, look into gold futures contracts. For those with some options understanding and experience, buying call options is another way to get gold exposure. Rare coins and jewelry are another investment method that also carries some artistic value.

Whatever you pick, make sure to thoroughly research your investment, its transaction and price mechanisms, and the commissions and fees you’ll be paying.

All of the investment methods discussed have differing tax implications depending on where you reside, which could influence your decision on how you invest in gold.

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