Investment Insider: Problem with gold is it's impossible to know the real value

Over the past 10 years, the price of gold has climbed from around $350 an ounce to over $1,800.

But since reaching its peak in August 2011, prices have declined to $1,600. In recent weeks, the slow decline turned into a rout as prices plunged to around $1,300. Earlier this week, gold posted its biggest one-day fall in 30 years, slumping nearly 10 per cent.

Some people claim gold can be a haven in times of trouble, which could explain why many bought gold in the past decade.

The buying of a product solely because its price is rising was brought to the fore when many investors swapped their hard currencies for Bitcoins. These are a virtual currency generated by computers. They can be bought through online exchanges and stored in virtual wallets to buy goods later. But what makes them special is that their value can change with demand. Last year, one Bitcoin cost around $10 but the same coin rose to more than $200 before falling back to $50.

The argument for owning Bitcoins bear an similarity to owning gold, namely they are untethered to sovereign currency, but just as they abruptly lost their attraction, so too can gold. Last week's collapse was sparked apparently by news that the US economy may be on the mend; growth in China failed to meet expectations, so inflation may be curtailed, and Cyprus may have to sell some of its gold reserves to fund its bailout. If a country as small as Cyprus can send the market tumbling, what exactly has been holding it up?

And therein lies the problem. Stock market investors understand the impact of supply and demand on, say, share values. Shares can be valued on cash flows you expect through holding the investment. So it is always possible to determine if it represents good value. But gold is only worth what someone is prepared to pay, which could be based on their own fear, greed or a combination of both.

There is no denying that buyers of gold a decade ago are sitting on around 300 per cent gains. But, as an investor it helps to know what an investment is worth and why it has risen in value. If you don't, how can you know whether it is still worth holding at any price?

David Kuo is director of fool.co.uk

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

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