Gold price: This is why gold may not be as safe as you think

The gold price hit a five-year low on July 20. Should we care?

(Royal Mint)

The gold price hit a five-year low on 20 July, tanking 4 per cent in just a few minutes after the Shanghai gold exchange opened. An ounce of gold dropped in price to $1088. Some analysts expect it to fall below $1000 by the end of the year.

Investors in gold watched their holdings decrease in value and started looking for reasons for the crash.

Some noted that when the chair of the Federal Reserve, Janet Yellen, suggested that interest rates might rise in the near future, she implicitly told investors in gold that they might be better investing in other assets. That’s because gold brings no income – in fact it costs money to store it.

Others said the breakthrough in the Greek debt crisis and the Iran nuclear treaty have made investors more optimistic about global economic prospects. Which means that fewer might turn to gold as a 'safe haven' for their money when they can get decent returns elsewhere.

Gold is traditionally used as a hedge against inflation. The idea is that it doesn’t gain value, but it doesn’t lose it either. If a government starts printing money and the value of the dollar decreases, gold should still be worth the same.

This leads some to believe that gold is a more reliable economic indicator than money.

But as the chart below shows, the gold price has risen much more dramatically than UK prices.

And gold does still rise and fall in value. When its value crashes, like it did on July 20, investors will lose out.

"What motivates most gold purchasers is their belief that the ranks of the fearful will grow," Warren Buffett said in a 2011 letter to investors in his company Berkshire Hathaway.

"As 'bandwagon' investors join any party, they create their own truth – for a while. Bubbles blown large enough inevitably pop.”

"Gold is the ultimate greater fool asset - the only reason anyone will buy it is because they think they can sell it to someone else for more," said Guy Foster, Group Head of Research at Brewin Dolphin.

Investors hoping that gold would protect them in the uncertainty that followed the financial crash in 2008 may have found that, now the ranks of the fearful are falling, holding too much yellow metal isn't such a great idea.