Portfolio diversification refers to reducing investment risk by purchasing a variety of assets. A random selection of assets already reduces risk, compared to a one-asset investment. However, diversification is more efficient, if the portfolio assets are not correlated, i.e. they do not move into the same direction. Investors seek a portfolio that has a minimum of risk and a maximum of return.
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Gold is often regarded as a perfect inflation hedge. Let’s discuss this issue by answering the following three questions: First, what is inflation. Second, what are the reasons for inflation? Third, is gold an effective hedge against inflation?
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Why the gold price can only go up in the long term
First, gold is a finite resource, whose underground reserves will eventually be completely extracted. Second, gold population is growing and prospering. This increases gold demand for jewellery and industrial purposes. Third, central banks have been increasing their gold reserves. All of this points towards an inescapable raise of gold’s value and its price.
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A gold scam is either 1. downright fraud, 2. misrepresentation or 3. market manipulation. To be knowledgeable about gold scams is necessary to anticipate and avoid them.
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The political risk of gold investing means that the government can change laws and regulations that may harm your investment in gold. These government interventions can happen in the country of the investor or in another country. Both would have an impact on the gold price, as supply and demand, or the invisible hand of the market will be disturbed.
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Exchange risks refer to the exchanges where gold and futures are traded, and not to currency risks. The two major gold futures exchanges are the New York Mercantile Exchange (NYMEX) and the Tokyo Commodity Exchange (TOCOM). Trading at these and all other exchanges is subject to their rules and regulations. The exchanges can on purpose or accidentally foster market outcomes by changing their trading rules.
What events could happen at an exchange?
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The price of gold, as of every traded asset, is subject to the ups and downs of the market. The rate of this precious metal can fluctuate fundamentally. The volatility of gold must be a concern to all short- and long-term investors.
Its perceived value is shaped by demand and supply. The factors are gold production by gold mines, central banks, investors and the industry (jewelry, electronic etc.).
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The first downside of gold investment is the physical risk. Buying gold bars and coins exposes the investor to the risk of loss and theft.
Costs are involved to mitigate this risk. The transport of gold needs to be insured, gold has to be kept in a personal safe at home, or, better, in the bank’s safety deposit box. Here, renting fees incur.
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