THE INVESTMENT VALUE OF GOLD IN GLOBAL FINANCIAL MARKETS.

By

Gavin Henning

Student Number: 7505086

Submitted in Accordance with The Requirements

For The Degree Of

B.Com Honours

In The Subject

MANAGEMENT ACCOUNTING at the

UNIVERSITY OF SOUTH AFRICA

SUPERVISOR: B. Van der Pohl.

DECLARATION

I Gavin Henning, student number 7505086 do declare that:

THE INVESTMENT VALUE OF GOLD IN GLOBAL FINANCIAL MARKETS.

is my own work and that all the sources that I have used or quoted have been
indicated and acknowledged by means of complete references?

Signed: Date: 16/06/2017

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Table of Contents

TABLE OF CONTENTS........................................................................................................................................2

1. SECTION I : BACKGROUND....................................................................................................................3

1.1. INTRODUCTION...................................................................................................................................3
1.2. PROBLEM STATEMENT.....................................................................................................................9
1.3. PURPOSE OF THE RESEARCH.........................................................................................................10
1.4. OBJECTIVES OF THE RESEARCH...................................................................................................10
1.5. RESEARCH QUESTIONS...................................................................................................................11

2. SECTION II : THEORY AND LITERATURE REVIEW......................................................................12

2.1. THEORETICAL FOUNDATIONS......................................................................................................12

2.2. LITERATURE REVIEW......................................................................................................................13

3. SECTION III : RESEARCH METHODOLOGY....................................................................................23

4. SECTION IV : CONCLUSIONS...............................................................................................................26

5. BIBLIOGRAPHY........................................................................................................................................31

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 1. SECTION I : BACKGROUND

1.1. INTRODUCTION

Investment has been defined as the use of money in order to make more money or to
profit from the arrangement, (Wardrope, Flynn, Gould, Hoagland, English & Sprague,
2014). Choosing investments is subject to the goals of the investor. Goals such as
yield, risk, duration, liquidity and tax consequences influence the perception of the
value of the investment to the investor. (Reamer, 2014).

A portfolio is a group of investments with different risk and return patterns owned by
an investor (Vigario, 2008). Investors will choose the type and quantity of assets to
be held in their portfolio according to their unique investment horizon and
circumstances. Investors with interests in high risk investments will usually require a
high yield from the investment in order to compensate them for the higher risk.
Correspondingly, low risk investments usually carry with them a lower yield over time.
Reamer (2014). Financial planners may recommend investments with low risk to a
pensioner, but with higher risks and higher yield to a younger person due to the
duration of the investment and longer time horizon available to correct the risk of
short term negative movements in price (Wardrope et al; 2014). Thus the perceived
value to the investor of a specific investment, like gold for instance, will be influenced
by whether they are seeking a high yield investment or just a low risk, safe place to
store their wealth.

Investment can either have the purpose of speculation or hedging.

Speculation is investment with the sole aim of profiting from the exercise by
increasing the value of the initial amount over time, and is sometimes further
subdivided into profit making – buy low and sell high, and value investing – buy
below market rate and sell above market rate (Reamer 2014). Hedging is investment
with the dual aim of firstly safeguarding and secondly maintaining the initial value of
the investment. This can be summarized as being a store of value. Hedging may also
seek to increase the initial value of the investment, but only by as much as is needed
to avoid financial loss from inflation or similar factors (Wardrope et al; 2014).

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An Investment in gold has for many thousands of years been used as a hedge to
safeguard the original value against the dangers of wars and calamites, as well as
against inflation and unstable economies, because it is valuable, easily transportable,
durable and universally accepted (Naidoo and Peerbhai 2015). Gold has not only
throughout history been primarily utilized as a store of value or hedge but also as a
means of exchange and as a unit of account (Bott, 2013). These three qualities
traditionally would define what is also known as money, or currency. The Lycian
Kingdom in the region of present day Turkey, had already established the first gold
coinage currency system around 630 BC (Osman and Özgün, 2016). Thus, as per
Bott (2013) gold has for many thousands of years been used as a substitute for
paper currency and bartered for goods and services, and this has resulted in a
sophisticated global market having being been developed over the centuries in order
to trade gold and gold derivatives.

Emmrich and McGroarty (2013) find that investing in gold as a hedge or store of
value has once again, as periodically throughout history, come back into fashion for
institutional investors due to a tempestuous economic climate. The global economy
has in the last decade been swayed by very low interest rates, low fixed income
yields as well as equity market turbulence, particularly after the 2007 global financial
crisis and resulting recession. Historically as well as currently, certain cultures and
countries have attached greater importance than others to the value of gold as a
hedge or store of value. Notable in this respect are India, China and Turkey.
McKechnie (2014) found that travelers from China and India were some of the main
customers of Dubai’s booming gold market, and that their bustling gold souks sell the
majority of their gold to Indian tourists. McKechnie (2014) also found that that the
main market driver of these sales was for investment purposes, as a store of value
for the future, and ultimately to be passed on as an inheritance to their children.
Turkey was likewise found by Osman and Özgün (2016) to consume up to 5% of the
world’s yearly production of gold, mainly for hedging purposes.

Gold has thus been primarily associated with a role as a store of value throughout
history, and only in second place as an investment for speculative purposes in the
global market (Bott, 2013). The speculative role of gold has however, as per Blose
and Gondhalekar (2014), been boosted in the last decade by one of the most
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dramatic increases in the gold price in history, where an investment of 1 U.S Dollar
($1) in gold in 2004 would have grown to $3.65 by 2012 (Blose and Gondhalekar
(2014). This dramatic increase in price is illustrated in figure 1 below.

Figure 1: Gold Spot Price: 1996 to 2016

Source : http://goldprice.org/live-gold-pr [Accessed June 2017 ]

This shows that there is another side to the value of gold in international
markets, one that may be geared toward profit, in addition to the traditional
value as a hedging instrument.

One of the most obvious factors that will influence the value of gold as an
investment commodity is aggregate demand and supply of gold. If demand is
increased but supply remains static it will cause gold prices to rise and visa
versa. Additionally, if supply decreases but demand remains static it will also
cause the price to rise and visa versa (Reamer, 2014). Gold has a number of
unique properties that influence its demand. Firstly, global supply is very limited
due to its scarcity and thus it has value in its scarcity. Gold also has a number of
other properties such as very high electrical conductivity, high ductility,
resistance to corrosion, divisibility due to softness and portability due to density.
Eichengreen and Flandreau (2005), also (McKechnie, 2014). The supply of gold
is influenced by the number of mines producing gold (Areal, Oliveira & Sampaio
2014) as well as by the sale of gold by central banks (Bott, 2013).

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If demand for any of the unique properties of gold increases or decreases
globally it will also influence the demand for gold itself (Bott, 2013). If
technological development and industrialization is advanced, demand for gold is
increased as well since gold is used extensively in electronics and other industry
due to its unique properties of ductility, conductivity and corrosion resistance.
Other demand factors may also cause an increase in demand for gold, for
instance in dentistry, in jewelry or coinage (Bott, 2013).

Furthermore, if global demand for gold is increased artificially for any reason
such as increasing demand for industrial use in electronics, or increased sale of
jewelry caused by government development of jewelry markets, but supply
remains the same, then it will automatically affect the value of gold as an
investment in a number of ways. Firstly, increased demand will cause the price
of gold to rise and that will cause increased interest for speculative investment
purposes. Secondly it will cause increased liquidity in the gold market which
means it will be easier and faster to sell one’s investment than before, and that
will attract investors concerned about liquidity issues. Thirdly it will mean
increased public interest in gold and thus more possibility of somebody deciding
to invest in gold than before (McKechnie, 2014).

Demand can also be influenced by government policy. The opening of the Dubai
Multi Commodity center and associated gold souks or markets by the
government in the UAE, in order to encourage precious metal trading, is a good
example of how demand for gold can be manipulated by government policy
(McKechnie, 2014). After applying this policy, the United Arab Emirates (UAE)
rose to become one of the top 5 gold sellers in the world, even though the UAE
of which Dubai is a part have no physical gold mines at all. McKechnie (2014)
further iterated that demand for gold as an investment from Dubai has been
increased by high standards of gold purity (99.9%) enforced by the government,
as opposed to 99% in Hong Kong and 96.5% in Thailand. These are examples
of how government policy can affect the demand for gold, as well as the value of
gold as an investment as opposed to the value of gold as jewelry alone.
The global demand for gold is can be subdivided into investment purposes
(36%), government treasuries (12%), thirdly jewelry production (43%) and lastly
other uses (8%) (Emmrich and McGroarty, 2013).
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Figure 2 : Demand for Gold in 2012

Source : Emmrich and McGroarty (2013)

In centuries gone by gold was used as a means of exchange, or more simply put as
money, because of its scarcity value and portability. When paper money was
invented in late economic history, for each dollar of paper money issued by the
government, the same amount of gold had to be stored in government bank vaults in
order to back up the paper issued. For many years it was possible to present the
paper money to the central bank and receive gold in return (Eichengreen and
Flandreau, 2005). During world war 2 the global monetary system was in confusion
but after WW2 the major global powers concluded the Bretton Woods agreement
which once again ensured that the Dollar and other major currencies value were
pegged to the value of gold (Eichengreen and Flandreau, 2005). This fact firmly
cemented golds status as a major global investment commodity. The annual demand
for gold was driven to a major extent by buying by central banks, and gave gold a
highly regarded status as central to the economic structure of the major powers (Bott
2013).

However, around 1971 the USA made a transition to the ‘fiat system’ during the
‘Nixon Shock ‘and ceased to peg the value of the dollar to real gold thereby ceasing
to back up every dollar issued with gold stored in vaults. The other major currencies
of the world soon followed suit and Switzerland was the last currency to switch to the
fiat system. (Eichengreen and Flandreau, 2005).

This major change that took place in late modern history meant that paper money
could simply be printed and used by any government to pay for goods and services,

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as well as expensive wars, without backing the value of the paper issued with gold or
any other commodity. This naturally caused concern as to the stability and safety of
major currencies as well as concerns as to what would happen with inflation and
exchange rates, since paper currency was and still is the basis of all the world’s
economies (Parker and Whaples, 2013). The economic effects of this still get
debated and considered in relation to major economic events in the modern world, as
with the global credit meltdown in 2007, and the failure of many governments to
service their debt, such as those of Greece and Ireland (Bott, 2013). This also poses
an important question on the value of gold as an investment in today’s global
financial markets. Has gold itself become less important as an investment commodity
globally now that the Bretton-Woods agreement has ceased to exist? Another
question can also be raised, namely hasn’t the opposite perhaps happened and has
gold not now become more important as people look to gold as a hedge and a
measure of security against uncertain paper currencies and economic difficulties
faced by many countries?

Figure 3 : Government Gold Reserves Jan 1957 to Sep 2012 (millions of oz.)

Source : Bott (2013).

Gold is traded in many ways, not only in bullion form. Bullion mainly takes the form of
gold bars in standard sizes Bott (2013). Many investors invest in gold on the global
market by using gold proxies as an investment vehicle instead of bullion. Different
types of gold proxies exist including gold mutual funds, gold exchange traded funds
(ETF’s), gold mining company equities, gold coins and gold jewelry. (Areal, Oliveira &
Sampaio 2014).
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Investors in gold on the global markets of today are very sophisticated and much
importance is attached to modern investment theories when capital allocation
decisions are made (Wardrope et al; 2014). Diversification of investments in order to
pool and minimize risk attached to individual assets is an important issue. Emmrich
and McGroarty (2013) found in studies conducted by them that large scale investors
tend to value gold as an important diversifying asset, along with small cap and
emerging market equities, rather than as a core portfolio component.

Another important factor is portfolio theory which stresses the importance of investing
in assets with differing statistical correlations in order to minimize the risk and
maximize the yield of a portfolio of investments. Areal, Oliveira & Sampaio (2014)
found that gold is always negatively correlated with the stock market, thus it has
value as an investment whenever equities are included in a portfolio. Emmrich &
McGroarty, (2013) noted that it is advisable to include gold in an investment portfolio,
however large amounts of gold are seen as improbable due to the fact that the
performance of stocks is better than gold in the long term. They found that amounts
over 10% of the portfolio value are unrealistic because equities have a higher rate of
return than gold, but are far more volatile meaning they rise and fall more often and
in greater measure than gold does. Gold have been shown to be an excellent store of
wealth due to the fact that its value is not very volatile, but extremely stable. Thus it is
a good way of safeguarding wealth., however considering that equities are highly
likely to found in a large majority of institutional investment portfolios, 10% of the
global value of these portfolios would place the global value of gold as an investment
in very high regard indeed if the findings of these authors were to be adhered to.

1.2. PROBLEM STATEMENT.

Emmrich and McGroarty (2013) concluded that investment in gold is back in fashion,
and that the value of gold as a diversifying investment has become particularly strong
since the global financial crisis of 2007.

Areal, Oliveira & Sampaio (2014) found that gold has a high value as a hedge due to
its properties of negative correlation with equites, but that gold proxies such as gold
mutual funds may have less value as a hedge since they were found to have lower
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negative correlation with equities especially during times of financial crisis. However,
Lucey and Li (2014) found that gold and gold proxies may lose their normal
correlation properties during times of financial crisis, and this may mean that there
may be a conflict in the value of gold to investors when regarded as a hedge and
even more so when regarded as a safe haven. This presents conflicting results that
may be clarified in further studies of the value of gold against its proxies and their
correlations to other market assets.

This study seeks to examine the different factors that affect gold in the role of an
investment commodity on a global scale, and furthermore clarify the value of gold
and separately gold proxies in investment portfolios considering separately their
correlations to other investment assets and their diversifying value.

1.3. PURPOSE OF THE RESEARCH

The purpose of this study is to examine the value of gold as an investment on a

global scale, and attempt to clarify the individual effect that each of the factors which
affect the value of gold as an investment have on the investment decision. This
analysis may assist investors and other interested parties in formulating an
investment approach to gold and determining the individual and collective influence
that the various factors have on the importance of gold as an investment by itself or
as part of a diversified portfolio of investment worthy assets.

1.4. OBJECTIVES OF THE RESEARCH

The specific objectives of this study are to:

 Determine what the current status of the value of gold as an investment in

global markets is after the effects of changes in the currency system and
economic climate in modern history.
 Analyze when, and which investment vehicles, such as jewelry, ETF’s, mutual
funds or stocks in gold mines can be regarded as being a suitable proxy for
investment in actual gold in our modern context.
 Thirdly this study seeks to conceptualize the factors which affect the value of
gold as part of a varied portfolio of investments in the modern sense.
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 1.5. RESEARCH QUESTIONS

 What is the current status of gold as an investment considering the effects of

changes in the currency system and economic climate in modern history?
 Which investment vehicles such as jewelry, ETF’s, mutual funds, coinage or
stocks in gold mines can be regarded as being viable proxies to gold bullion in
our modern context.
 What value does gold have as an investment when considered as part of a
portfolio of investments, diversification, speculation safe haven or hedge?

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 2. SECTION II : THEORY AND LITERATURE REVIEW

1.6. THEORETICAL FOUNDATIONS

A number of major theories have been developed to evaluate investments. These

theories are used to measure the profitability and soundness of an investment of
capital in either one or more assets (Baddeley, 2003).

As has been mentioned before, a portfolio is a range of investments in different

assets held by a person, such as gold, shares and real estate (Vigario, 2008).
Modern Portfolio Theory is a method described by economist Harry Markowitz which
uses the statistical correlation of risk between different investments to determine
which assets to hold in a portfolio in order to maximize return for a given level of risk.
This method is useful in balancing the total risk of a portfolio by making sure that the
risk attached to one asset is not the same as the risk attached to all other assets so
that a disaster or unfavorable circumstances for one asset will not mean that all
assets are affected at the same time (Vigario, 2008). This theory is thus used to
calculate what percentage of each asset, for instance gold, equities or real estate,
should be held in a portfolio in order to minimise risk and maximize returns.

Another theoretical foundation is “Diversification”. This theory stresses that no single

portfolio should invest in only one type of asset. The range of assets invested in must
be diversified in order to minimize risk and maximize return (Vigario, 2008).

Lastly, the Marginal Efficiency of Capital (or MEK) by the economist John Maynard
Keynes is a theory that warrants mention in the application of investment theory to
the gold market. This theory surmises that the Marginal Efficiency of Capital is the
discount rate that makes all future revenue from an investment equal to its current
replacement value (Baddeley, 2003). This relates directly to the net present value (or
NPV) of an investment which is the difference between all cash outflows and net
projected inflows relating to an investment (Baddeley, 2003). In other words, the
discount rate is the profit percentage one may expect to receive from an investment
over time. If this profit is negative it becomes a loss. This applies particularly to
investments such as gold, silver or real estate which may not necessarily yield any

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apparent income like dividends or interest. This theorem is useful to consider when
calculating whether an object such as gold, silver or real estate is worth keeping
when compared to income producing assets such as bonds or equities (Vigario,
2008).

1.7. LITERATURE REVIEW

(A) The Current Status of the Value Of Gold as an Investment after Considering
the Effects of Changes in the Currency System and Global Economy.

According to Lucey and Li (2014) the value of gold today, as throughout history, is
still dominated by its demand as a monetary asset. Gold is one of the 4 major
precious metals traded globally on most of the world’s major financial markets
(Wardrope et al; 2014). Conversely the demand for silver, palladium and platinum,
the other three precious metals of the group of four, is mostly for industrial use
(Lucey and Li 2014).

The monetary system of the world, as well as the world economy, has however
changed dramatically in the last century. These changes need study and insight
before the current status of the value of gold an investment on a global scale can be
evaluated. As a monetary asset gold has historically been used in 2 different ways.
Firstly, gold has been used directly in its physical form as a means of exchange,
either as coinage or in its raw form in whatever shape or size it may exist in (Bott,
2013). The second way that gold is used as a monetary asset is as a basis for paper
currencies. In England in previous centuries some of the earliest forms of money
were certificates of deposit from the major goldsmiths in London, whereby one might
deposit a certain amount of gold with them and in return receive a receipt, as proof of
deposit, on a piece of paper. These certificates of deposit were sometimes used as a
means of exchange or barter and were thus one of the first forms of paper currency
(Kim, 2011).

Certain goldsmiths in the larger cities of the ancient world, including London, began
to exchange foreign and domestic gold coins, and using the profit from their ventures
they also began to extend loans to the public (Kim, 2011). Seeing that they were in
the center of minor paper money gold deposit systems, lending business as well as
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general gold dealing, they soon began to start taking deposits from the public and
issuing paper debts for them, turning them into one of the biggest debtors in all of
England. These were the beginnings of the banking system with gold as the backing
for paper money in the western world, also called the ‘gold standard’, which persisted
in various forms until around the 1970’s (Kim, 2011).

These were the beginnings of the years of the gold standard, but the events
constituting the heyday of these times, well as the events which led to the demise of
gold backed paper money, need to be understood in order to gain a clearer picture of
how these major economic events may have had an impact on the value of gold on a
global scale in the modern economy today.

After the humble beginnings of paper money in a form of certificate of deposit for gold
deposited with a goldsmith, as time advanced so too did the standards governing the
trade in gold. Around the seventeen hundreds the Bank of England began to only
accept gold of a specific standard of purity, and that was required to be assayed at
the royal mint by the kings appointed gold assayer in order to ensure purity (Bott
(2013). The reliance placed on gold by the banking system as well as the high
standards of purity maintained by the governments could logically only elevate the
value that gold may have held in the eyes of investors. However, following Kim
(2011), certain events were to cause the scrapping of the ‘gold standard’ by all of the
central banks of the world eventually, could this possibly have been caused by a
breakdown of the trust placed in gold, or have even led to a decline in the confidence
that global investors placed in gold from then on? Did the opposite perhaps happen
and a flight to the safety of gold start with these events? The events which led to this
state of affairs need to be examined in order to formulate an answer.

Soon after the advent of goldsmith’s gold deposit notes being used as currency,
governments began to catch on to the new trend and started issuing their own paper
money, backed by gold held in their treasuries. These paper notes were generally
convertible on presentation at the treasury or central bank into actual gold bullion
(Eichengreen and Flandreau, 2005). However, during the Napoleonic Wars, the first
of a series of government legal moves began which would eventually culminate in the
global scrapping of the gold standard. The English parliament suspended the
convertibility of paper money because of the pressure of war finance and the
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resulting difficulty of honoring the amount of requests for conversion to gold that they
were receiving. After the war ended in 1821, they once again passed a law requiring
the Bank of England to honour the redemption of its notes at the prevailing market
price of gold. (Eichengreen and Flandreau, 2005). However, banks soon started the
practice of issuing more paper money than gold actually owned, with the laws of the
time generally requiring not more than around 40% of the value issued to be retained
in bullion. This practice led to one after another central government experiencing
issues with redemption. In 1890 and 1907 economic crisis led to investor panic and
twice England had to lend millions of pounds in gold from France and Russia in order
to honour conversion payments (Bott 2013). At the beginning of WW1 the gold
system was forthwith abandoned due to war finance pressures and mass conversion
requests in fear of the war. After the war it was once gain continued but again
collapsed between 1936 and 1938 near the start of WW2, for very much the same
reasons. (Bott 2013). After WW2 the gold standard was again instituted with an
agreement between the major world powers which was to be called the Bretton-
Woods agreement. However, the USA experienced problems honouring conversions
during the great depression and eventually resorted to making it illegal to own gold
bullion in order to stem the tide of requests.

According to Eichengreen and Flandreau (2005), it remained illegal to own gold in

the USA for the next 40 years, until 1971, during what is now called the Nixon crises,
the USA followed shortly thereafter by the rest of the world’s currencies, finally
abandoned the gold standard and started the advent of the fiat system. This refers to
a currency system where paper currency is issued without any security such as gold
backing it up. One can see in figure 4 below how the price of gold suddenly
increased around this time and became more volatile, even going through periods of
large price drops at times. This raises the question of how this change has affected
the value of gold as an investment on the global markets since then. Lucey & Li
(2015) found that other precious metals such as silver tend to act as a safe haven
when gold does not. Could this indicate that gold has lost part of its value as an
important part of every investment portfolio?

Figure 5 : GOLD PRICE FROM 1833 TO 2008

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 Source : (Shafiee, Topal, 2010)

The economic climate in modern times also needs to be taken into account when
considering where gold stands an investment today. Jones and Sackley, (2016)
found that an economic policy uncertainty indicator studied by them was positively
correlated to the price of gold. This means that when the indicator showed a
consensus of uncertainly about economic policy by the public, it caused the price of
gold to rise significantly. As per Emmrich and McGroarty (2013), equity market
turbulence as well as historically low fixed income interest rates have actually caused
gold to become more interesting to investors. Additionally, Pullen, Benson & Faff,
(2014) noted that the recent rise in terror attacks throughout the world has also
caused a flood towards safe havens and hedge investments on a global scale. Gold
was found to be a major safe haven asset and a hedge against volatility by Lucey
and Li (2014). Thus Pullen, Benson & Faff, (2014) concluded that gold has definitely
seen an increased interest in its value as an investment asset as a safe haven, and
as a hedge investment in the current economic climate, as clearly shown in figure 4
below. It was also demonstrated by Pullen, Benson & Faff, (2014), that when gold is
compared to equities in the form of the S&P 500 index, one can clearly see the spike
in the price of gold due to massively increased demand during the 2007 global
financial crisis when equities clearly fell through the floor. This is clear evidence of
the continued value placed by investors in the use of gold as a safe haven in times of
crisis.

Figure 4: Total Gold Investment Demand and SAP 500 Comparison.

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Source: Pullen, Benson & Faff (2014).

In addition to this Baur and Dimpfl, (2016) found that economic news on a much
smaller and more focused scale can also have an impact on the value that investors
place on gold. They discovered that a preponderance of bad mining news in today’s
economy appearing high in the list of most searched items on search engines,
usually correlated with an increase in the gold price, and visa versa. Smales (2014)
also found compelling evidence in support of his hypothesis that negative news in
general caused a greater positive response from the gold price than other news.

(B) Which Gold Proxies such as ETF’s and Coinage are to be Valued as an
Investment in Gold in The Modern Sense?

In many countries during various times in history it has been illegal to own raw gold
bullion without a special license, for instance as happened in the USA during the
depression of the 1930’s. The government took this step in order to prevent mass
claims on the treasury for gold bullion during the panic of the depression (Parker and
Whaples 2013). This type of measure has occurred in England as well as in other
countries of the world for various reasons throughout history (Eichengreen and
Flandreau (2005). This fact means that gold proxies are very often the only legal way
that people can actually invest in gold, due to legal restrictions.

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Various studies have addressed the status of gold proxies and tried to determine to
what extent gold bullion correlates in risk and in yield to actual gold bullion.
Gold coins’ value to investors is affected by their collectability, scarcity and
manufacturing costs such as engraving and minting. Thus their yield and risk may
differ to that of gold bullion to some extent McKechnie (2014).

Gold mutual funds were addressed in a study by Emmrich and McGroarty (2013) and
were found to follow the behavior of gold bullion quite closely, although gold bullion
was found to be slightly more advantageous at increasing portfolio returns and
reducing portfolio volatility.

Investments in gold mining equities as proxies for gold bullion were however found to
be poor substitutes due to the influence of business risks, foreign exchange as well
as dividend polices of the company concerned. (Areal, Oliveira & Sampaio, 2014). In
addition, Reboredoa and Ugolinib, (2017) found the price of gold mining equities to
be poorly predicted by the trends in the gold price.

Gold ETF’s are another gold proxy that were studied by Emmrich and McGroarty
(2013) and they concluded that ETF’s were actually marginally better at lowering
portfolio volatility than gold bullion, although risk adjusted returns of bullion were
slightly better. Blose and Gondhalekar (2014) found that gold EFT’s which keep their
funds matched to the price of gold by continuous intervention, actually track the spot
price of gold very closely in reality, and are thus an excellent proxy for real gold
bullion.

Gold jewelry also has a slight flaw as a gold proxy in that the gold purity is usually
less than the 99% range of gold bullion (McKechnie, 2014), and of course the
obvious fact that the other precious metals and gems that are often included in the
structure will affect the price, as well as the subjective affect that the design of the
jewelry can often account for a large percent of its value to the investor. These issues
therefore question the validity of gold proxies to a certain extent and further
examination of their suitability may reveal other angles to be considered in further
study as they are clearly much used as gold proxies by investors on a global scale
(Emmrich and McGroarty, 2013).

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The Value of Gold as an Investment When Considered as Part of a Portfolio of
Assets.

When considering an asset as part of a portfolio of investments, the most important

characteristic to be considered is it’s diversifying capacity. (Baddeley, 2003). An
asset may act as a diversifier in a portfolio by being a safe haven, a hedge or
speculative asset (Bhanja and Billah, 2015). In either case the portfolio holder will
seek to choose the quantity and type of each asset according to its correlation with
the rest of the assets in the portfolio (Vigario, 2008).

A diversifier is defined as an asset which is not perfectly correlated with all the other
assets in the portfolio, while a hedge is an asset which is negatively correlated with
other assets in the portfolio at all times, and can be used to stabilise the portfolio
against the inflationary movements of the other assets. A safe haven though is an
asset which is strongly negatively correlated with other assets in the portfolio,
specifically in times of economic stress or crisis, and as such will act as an economic
safeguard at those times (Pullen, Benson & Faff, 2014).

Sharma, (2016) found that the consumer price index (CPI), which is a measure of
current inflation, reliably predicts the price of gold movements. This was seen as
evidence that gold is a good hedging asset against inflation. Pullen, Benson & Faff,
(2014) concluded that gold mutual funds, ETF’s and gold mining equities were all
good diversifiers in a portfolio containing a large percentage of various other equities,
but noted that they found that only gold bullion was a consistently good safe haven
during all economic recessions and crises that they studied.

Naidoo and Peerbhai, (2015) conducted a study on inflation figures in the South
African context and decomposed these figures into unexpected inflation, anticipated
inflation and total or actual inflation. They found empirical evidence that in the long
run both gold bullion as well as gold coinage in the form of krugerrands were
effective as hedges against actual inflation but not against anticipated inflation. Some
of the main factors mentioned in the study which caused this quality of gold, were the
facts that gold was easily transportable, durable and universally accepted. During the
study period between 2000 to 2014, they collected evidence displayed in figure 5 and
figure 6 below, that showed that the sub-group commodities, which includes gold,
outperformed the market significantly in times of severe inflation, but came

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approximately even with an assortment of other inflation hedges during times of less
severe inflation.

Figure 5: Performance of Assets in High Inflation Environments.

Source: Naidoo and Peerbhai, (2015)

Figure 6: Performance of Assets in Low Inflation Environments.

Source: Naidoo and Peerbhai, (2015)

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Figure 7 : Chart of CPI inflation vs Gold Price 2000 to 2014.

Source: Naidoo and Peerbhai, (2015)

In figure 7 above, Naidoo and Peerbhai, (2015) show how the price of gold neatly
tracks and remains ahead of inflation between 2000 and 2014, using CPI as a
measure of inflation for that time period. This proves that gold is an excellent hedge
against inflation.

Osman and Özgün, (2016) noted that inflation in Turkey is very high, and that this
fact, in conjunction with other local factors, could be the reason for the very high
recorded rate of investment in gold in that country. Turkey has consumed as much as
1/3 of the global production of gold coins and 5% of the total global production of gold
in certain years, even though it has a GDP of approximately only 1% of the world
GDP. (Osman and Özgün, 2016). They went further by calculating a recommended
percentage of 4% of gold to be held as a diversifier and hedge in a portfolio
containing amongst other assets fixed income securities such as bonds as a
diversifier, but recommended holding as much as 50% in gold in a portfolio that does
not contain fixed income securities. This calculation was performed due to the fact
that Turkey is a predominantly Islamic country, and fixed income securities or bonds
are forbidden by Islamic law. They concluded that gold is anti-correlated with most
other asset classes and that makes it an excellent diversifier and hedge.

Emmrich and McGroarty (2013) found that gold is an excellent diversifying asset in a
portfolio of investments, but that the percentage allocation to gold should not be too
high since it does not have the growth potential of equities, nor the income potential
of bonds, but rather acts as a stabilizer due to its quality of being negatively
correlated with most other common portfolio assets. They also found that ETF’s were
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marginally better at lowering portfolio volatility than what gold bullion is, although risk
adjusted returns were found to be better with gold bullion. They also found that gold
gold bullion was shown to be better at reducing portfolio volatility as well as portfolio
returns than gold mutual funds.

Bhanja and Billah (2015) concluded that gold was found to be both a safehaven and
a hedge at all times, which contradicts the findings of Lucey and Li (2014) who found
that gold was an excellent hedge, but did not perform as well as a safe haven during
all times of financial crisis. This presents contradictions in the literature which may be
addressed by further studies.

Lucey and Li (2014) found that gold’s volatility responds mostly to monetary variables
namely inflation, interest rate and growth rate in money supply, while the other three
major precious metals responded to both monetary and financial variables including
the S&P 500 equity index. They concluded that this quality set gold apart as an
excellent hedging and diversifying asset above the other three precious metals
palladium, silver and platinum. These findings of Lucey and Li (2014) together with
the findings of Bhanja and Billah (2015), Pullen, Benson & Faff, (2014) and Osman
and Özgün, (2016) all however point without fail to the fact that gold is an asset with
definite diversifying value to any global investor, no matter which country they may
find themselves based in. Additionally, these studies point to the fact that gold as an
asset should without question be included as a diversifier in most investment
portfolios.

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 3. SECTION III : RESEARCH METHODOLOGY

3.1 RESEARCH DESIGN

Research designs are a logical plan or blueprint that link the research objectives and
questions to the data to be collected and the strategies that will be used to analyse
the data (Yin, 2016).

The design methodology of this research study will be a nonexperimental study,

conducted by means of historiography and descriptive research. Descriptive research
describes the characteristics of an existing phenomenon, while historiography seeks
to understand the past history of a subject, which in turn can lead to significant
understanding of the current and future state of the phenomenon. (Salkind, 2013).

Kumar (2013) states that the functions of a research design are twofold. Firstly, an
operational plan must be conceptualized to outline the procedures that will be
required to undertake the study, and secondly the procedures that will be used to
ensure that the data is accurate and objective must be detailed. In line with the
second of these two requirements the historiography will be conducted according to
the principles for ensuring accuracy and objectivity in historic and descriptive studies
outlined by Salkind (2014). These principles include utilizing a variety of sources in
order to compare and verify facts and viewpoints, using peer reviewed academic
journals as data sources, and referring to academic sources are not outdated in order
to ensure authenticity and accuracy of the study. As per Salkind (2014) historical and
descriptive models do not offer the luxury of uncovering mathematical causal
relationships between specific variables, they can still be used to uncover and
describe relationships between variables. In the case of this study the variable
studied will be the value of gold as an investment and an attempt will be made to
uncover any relationships with other variables that may have historically as well as
currently affected the studied variable. According to Kumar (2013) a holistic approach
toward a research design is an approach based on a philosophy that many factors
interact in order to influence the activity of a phenomenon, and therefore a question
needs to be explored from different perspectives in order to understand it. The
research design will thus attempt to incorporate the holistic approach in order to
evaluate the subject of the research.

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3.2. SAMPLING

Sampling will not form part of this study since it is historiographic and descriptive in
nature.

3.3. DATA COLLECTION

Data that will be gathered will be secondary data in the public domain for which no
special permission need be sought out. Primary sources are firsthand accounts of
events and secondary data sources are at least once removed from the event, such
as a historic account of an event (Creswell, 2014). As per Dhawan (2010) in
descriptive studies the accuracy of the data sources used becomes a major
consideration, and a research design which minimises bias and maximises the
reliability of the evidence collected is most appropriate. In order to ensure these
outcomes, the methods prescribed by Yin (2016) of using rich and varied data
sources as well as frequent comparison between data sources will be employed.

3.4. DATA ANALYSIS

The data will be analysed using thematic analysis. The thematic analysis will be
performed using the methods described by Kumar (2012), by coding the data to be
used in phases to establish patterns in the data and then elaborating further on these
patterns. The coding will be done in phases by firstly reading the data, then noting
down themes or keywords on the major issues encountered in the text. Thereafter
the notes will be studied in order to identify patterns and themes in the codes. Once
these themes have been identified and arranged in line with the research problem,
they will be named and analysed in order to produce the final conclusion of the study.
As per Salkind (2014) data needs to evaluated before conclusions are reached and
findings are recorded in a qualitative research study, using two distinct criteria:
authenticity (known as external criticism) and accuracy (known as internal criticism).
External criticism will be applied to all historic data whether it be transaction price and
volume data that is only days old, or data that refers to events that happened a few
hundred years in the past. This criterion evaluates the authenticity of the data which
determines whether the data is genuine and trustworthy. For instance, questions
such as whether historical data regarding the price of gold was originally measured
Page 24 of 32
by a reputable source and reliably relayed by the historian, or whether the data was
gathered from unvalidated and possibly untrustworthy sources by the historian for
any reason, must be asked (Salkind, 2014). Internal criticism is another term for
trustworthiness, and related to the accuracy of data. All data gathered will be
evaluated for accuracy by asking questions such as whether the numbers and events
depicted seem plausible when compared to other historic and current sources, and
do the various data sources validate or possibly contradict each other when
compared? (Salkind, 2014). In addition to this, methods noted by Yin (2016) that can
additionally be used to validate qualitative data will be applied to all data collected to
augment the data validity. These methods include testing diverging data sources by
searching for contradictory information, and triangulation which is the comparison of
converging data from different sources and types of sources, such as graphic charts
versus historic written accounts of price movements.

3.5. LIMITATIONS OF THE STUDY.

According to Salkind (2014) historical research is tends to be limited by the fact that
the observations referred to tend to be not your own but reported, however he adds
that this is not a reason to ignore this type of data. The second limitation is that the
criteria of validity and reliability of empirical research tends to be less rigorous in
historical research, however the evaluation of the data needs to be more
comprehensive historic studies in order to make up for this. Dhawan (2010) states
that in descriptive studies accuracy becomes a major consideration that could be
seen as a possible limitation of the study.

3.6. ETHICAL CONSIDERATIONS.

Permission will be obtained from the supporting educational institution, namely

UNISA, for any data collection that affects other people or is not secondary in nature.
All sources of data and information will be citated in a bibliography and credit given in
order to avoid plagiarism. Unisa (2013) state that the institution follows a policy of
maintaining an ethical and scientific culture in research practice. Of additional
importance is that the institution states it does not intend to restrict or discourage
research through its ethical policy, but on the contrary to enhance the capability of
researchers to undertake ethical research and to maintain their independence when
Page 25 of 32
confronted with undue influence or pressure. The ethical principles of the institution
will in accordance with their policy be vigorously maintained in order to ensure the
conformity of the study.

4. SECTION IV : CONCLUSIONS.

INTRODUCTION:
Separate conclusions have been reach for each of the three major research
questions addressed in this study. The findings and conclusion to each question are
directly linked to the evidence considered when addressing each question, and thus
conclusions and the discussion on each conclusion are presented under separate
headings below, for each research question addressed.

CONCLUSIONS:

(A) The Current Status of the Value Of Gold as an Investment after Considering
the Effects of Changes in the Currency System and Global Economy.

Throughout ancient history Gold has had the status of being an investment that could
be used to barter for goods and services, as well as a store of value and safe haven
against disaster (Bott, 2013). The reason for this was due to its characteristics of
being valuable due to its scarcity, as well as being durable and easily transportable.
(Naidoo and Peerbhai 2015). Considering the modern age of electronic transfer of
cash to settle transactions, and the availability of paper money in every country in the
world today, the question presents itself of whether gold is still used as a major safe
haven and store of value? The current literature as well as the current information
available on the volumes and price of gold traded in the international markets
provides a certain amount of evidence to answers these questions.

Pullen, Benson & Faff, (2014) studied the relationship between the price of gold and
the S&P 500 equities index and noted that the price of gold worldwide actually
increased around the same time as the 2007 global financial crisis when the price of
equities fell significantly due to the crisis. This provides a very clear indication that
gold is still valued as an investment as safe haven by investors worldwide. This is

Page 26 of 32
shown as a spike around 2007 in the graph of figure 4 below. The graph shows the
price of gold continuing to increase at a time when the major stocks exchanges in
USA and Europe actually lost a large percentage of their value from the crash in the
price of equities.

Figure 1: Gold Spot Price: 1996 to 2016

Source : http://goldprice.org/live-gold-pr [Accessed June 2017 ]

Pullen, Benson & Faff, (2014) found additionally, that coinciding with the times of the
recent extremist terror attacks worldwide, the markets showed a marked increase in
the volume of gold purchased. This was also determined by them to be related to its
value as a safe haven and hedge investment.

One particular recent set of events relating to gold as a historic mainstay of the global
currency market has also led to the question of whether gold may have retained or
lost its ancient value as an investment for the reason of being a medium of
exchange. In ancient times gold bullion was used directly as a medium of exchange
(Bott, 2013). Later on with the advent of paper money, from the 17 th century until
approximately the middle of the 20th century, gold was used instead as the backing
asset for most paper money issued worldwide (Bott, 2013). However, in the early
19th century up to around 1971 most countries in the world slowly stopped using gold
bullion stored in central government vaults as a guarantee against the value of paper
money and changed instead to using a fiat currency system where there is no
definite asset stored against the value of paper money (Eichengreen and Flandreau,

Page 27 of 32
2005). This poses the question of whether the possible release onto the world market
of these vast quantities of gold that most central banks were legally forced to keep
but were later free to dispose of as they please, may have had an effect on the
investment value of gold itself. Two obvious scenarios to consider would be whether
these events may have caused the value of gold to become so volatile that it would
lose its interest to investors as an investment, and secondly the possibility that the
lack of focus on gold as a currency backer may have simply caused gold to lose its
appeal and renown as an investment and slowly become sidelined and disappear
from being one of the central pillars of the global investment scene.

The answer to these questions may be deduced from observation of the global price
of gold following the start of the modern fiat currency system, as well as from recent
peer reviewed studies conducted by researchers. Historic evidence on the standard
worldwide gold price from 1833 to 2008 as shown in figure 8 below actually shows
such a dramatic increase in the gold price corresponding with the beginning of the
70’s when the last of countries in the world stopped using gold as a currency
standard, that the only option is to deduce that the gold became far more sought after
as an investment than before this time.

Figure 8 : GOLD PRICE FROM 1833 TO 2008

Source : (Shafiee, Topal, 2010)

Secondly, the findings of current research published in the literature can also provide
evidence toward an answer to the question. Emmrich and McGroarty (2013)
conducted a study on whether gold still has a prominent place as an inclusion in
Page 28 of 32
large investment portfolios, and their conclusions showed that equity market
turbulence and very low interest rates in the last decade have caused gold to
become sought after by investors as a store of value investment, in much the same
way as it has been used for many centuries. Further evidence was provided by Jones
and Sackley (2016) in a study conducted by them using an economic indicator
developed to measure the amount of confidence that investors have in the market at
any one point in time. This could also be referred to as an uncertainty indicator. Their
findings pointed toward the fact that the global price and volume of gold being traded
daily rose significantly in times of uncertainty and thus shows that it is seen as a very
important and viable investment as a hedge and safe haven on a worldwide scale.

Thus as a conclusion it can be deduced that that gold has certainly not lost its
ancient lustre as an important investment in the global markets. Current literature as
well as empirical evidence of historical price and sales volume seem to indicate that
gold may actually be regarded as one of the most important investment assets
worldwide, along with the other precious metals, equities and bonds.

(B) Which Gold Proxies such as ETF’s and Coinage are to be Valued as an
Investment in Gold in The Modern Sense?

The findings of current research by peer reviewed authors can be used to deduce the
status of investments in gold proxies as as stand-in’s for gold bullion itself on world
markets.

Emmrich and McGroarty (2013) found Gold Mutual funds to follow the behavior of
bullion quite closely, although bullion showed slightly higher returns and less volatility
in price. Thus gold mutual funds would not be a perfect proxy for gold itself as an
investment. McKechnie (2014) found that the value of gold coins’ differs to plain
bullion of the same weight due to their scarcity, collectability and manufacturing
costs. Thus coins could not be seen as a perfect proxy to bullion even though the
price of these coins is partly determined by the world gold price. Additionally,
investments in gold mining equities were found to be poor substitutes for investments
in gold itself by Areal, Oliveira & Sampaio (2014) as well as Reboredoa and Ugolinib,
(2017).

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However, gold ETF’s (exchange traded funds) were identified by Blose and
Gondhalekar (2014) as very good proxies for an investment in pure gold bullion since
their price very closely tracks the world price of gold in all respects.

Thus as a conclusion, the best proxy for gold bullion seems to be gold ETF’s,
although the other gold proxies are certainly influenced by the global price of gold
and thus can be considered as viable alternatives in the same category but not as a
perfect substitute for gold.

(C) The Value of Gold as an Investment When Considered as Part of a Portfolio

of Assets.

In order to determine the value of gold on the global arena when looked at as part of
a portfolio of investments as a whole, current studies in peer reviewed academic
journals on the subject can be referred to and compared to each other to form a
sound opinion based on the latest academic findings on the question.

Osman and Özgün, (2016) concluded that gold is anti-correlated with most other
asset classes and as such is an excellent diversifier and hedge in a portfolio. They
further recommended that gold be held as a diversifying asset at up to 5% of the total
value of a portfolio holding bonds and equities, and at up to 50% of a portfolio not
using bonds as a diversifier.

Lucey and Li (2014) found that found that gold is an excellent hedging and
diversifying asset in diversified portfolios due to the fact that its volatility responds in
a positive way to inflation, interest rate and growth rate in money supply.

Additionally, Naidoo and Peerbhai, (2015) concluded in a study of gold as a hedge

against inflation that gold is a very effective overall hedge against inflation, and thus
is very important as a diversifier and hedge in any portfolio of investments.

Thus it can be concluded from the current literature that gold can be regarded as an
extremely valuable part of any varied investment portfolio, either as a diversifier or as
a hedge against inflation and economic crisis.

These findings would elevate the status of gold as an investment on a global scale to
being extremely important and much sought after.

Page 30 of 32
 5. Bibliography

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The European Journal of Finance, 21(6):507-526.
 Baddeley, M. 2003. Investment : Theories and Analysis. New York: Palgrave
Macmillan.
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Policy 50: 306–311.
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evidence from three major gold consumers', Economic Change & Restructuring.
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 Blose, L.E. and Gondhalekar, V. 2014. ‘Overnight gold returns’, Applied
Economics Letters, 21(18): 1269–1272.
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History. 2nd ed. London: Taylor & Francis.
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investment portfolios?', Applied Financial Economics, 23(19):1553-1565.
 Jones,A.T. and Sackley, W.H. 2016. ‘An uncertain suggestion for gold-pricing
models: the effect of economic policy uncertainty on gold prices’, J Economics
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 Naidoo, K. and Peerbhai, F. 2015. ‘An Evaluation Of Gold As An Inflation Hedge:
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