The price of gold has rallied strongly over the last five years.

When the Global Financial Crisis started back in 2007, you could pick up an ounce of gold for just $670.

Wind the clock forward to today, and gold is now trading at $1690 – a rise of over $1000 per ounce.

The increase in price has led many market pundits to declare gold is ‘in a bubble’ and the price will soon crash.

In this article, we look at some of the myths about gold and debate the questions that regularly come up about this asset class.

Some of the questions commonly asked about gold include:

What is gold?

Is gold just another commodity?

Is the gold market an illiquid and obscure market?

Who owns the world’s gold?

Is gold really in ‘a bubble’?

Let’s look at each of these in turn.

What is Gold?

Gold is a monetary asset. There are two forms; gold (and silver) and paper money.

Over the long run gold is a far superior form of money than the paper dollars we are paid in and store in our bank accounts.

This is because gold, the supply of which is both finite and stable, is immune to the ravages of inflation that always end up reducing the value of paper money.

Is Gold just another commodity?

Gold is not a commodity, like wheat or oil, because it isn’t used up like other commodities are.

Wheat and oil are valuable because they are consumed (used either to eat or run an engine etc.).

Nearly all the gold that has ever been produced is still available (it’s either being worn as jewellery, sitting in a safe deposit box or being stored in a central bank vault).

Is the Gold Market illiquid and obscure?

The gold market is neither obscure nor illiquid. In fact it is huge. The value of all the above ground gold in the world is roughly US$9 Trillion dollars. That’s over six times the size of the entire Australian economy.

It’s also a highly liquid asset. Over $30 billion a day of gold is traded on the London Bullion Market, six times larger than the daily volume traded on the Australian Stock Exchange.

Who owns the World’s Gold?

Nearly 50 per cent of all gold holdings in the world are held in jewellery form.

The rest is predominantly held either by private individuals or by the central banks of the Western world.

These central banks and governments, including those of the United States, Germany, France and Italy hold three quarters of their foreign reserves in gold, highlighting the fact gold is an asset of strategic importance to their overall economic stability.

Governments in emerging markets (China/Russia etc.) are also busily acquiring gold to help diversify their asset base, with imports of gold into China from Hong Kong nearly quadrupling between 2010 and 2011.

Is Gold in a bubble?

And so to the last and most important question – is gold in ‘a bubble’?

To debate this point, it’s important to look at some relevant ratios to help come to a conclusion.

Whilst the gold price is no longer ‘cheap’ in nominal price terms, when you look at gold vs. the equity market, gold vs. inflation, or gold vs. the paper money supply (remember central banks are creating money out of thin air these days), gold remains much under-priced by historical standards.

To give just one example, if the ratio between gold and equities was to reach the same level it does in typical gold bull markets, the gold price will need to go over $10,000 (or the equity market will need to crash).

This is not a price prediction, but a useful number to keep in mind, and offers a strong rebuttal to anyone who suggests gold is ‘a bubble’ today.

Whilst there is good reason to think the gold price will continue rising, it is important that investors and potential investors in gold understand that the metal can be volatile in the short term (like the share market), and that the price will not go up in a straight line.

Significant corrections in price are a common trait of any major bull market, and gold is no exception in this regard.

Over the last decade (a period in which gold has gone from $255 to around $1690), there have been three major corrections.

The fall in the gold price during these corrections has been between 16 per cent and 29 per cent.

These numbers should help put the current pullback in price (from $1895 in September last year to $1531 in December) into context. That’s a fall of 19 per cent.

Whilst it’s never nice to see your assets fall in price, this is a perfectly healthy and normal correction in an ongoing bull market.

To give even more historical context, back in the 1970’s gold bull market, there was actually a period where the Gold Price fell just under 50 per cent at one point (from $193 in December 1974 to $104 in August 1976).

No doubt investors who bought in around $190 felt very nervous about their gold holdings after a fall like that.

Had they sold their gold though after that correction, they would have not only locked in a loss on their investment, but more importantly, missed out on one of the great bull markets of our time as over the next four years the gold price went on to trade at over $850 an ounce.

Finally, it’s important to remember what ended the last Gold Bull market back in 1980. Interest rates were over 15 per cent at the time. Obviously, the higher the rate of return you can get on paper money, the less attractive it is to hold gold, and vice versa.

This is exactly the economic environment we find ourselves in today, with interest rates in the majority of the developed world negative in real terms.

Considering the debt problems these countries face, interest rates may well remain negative in real terms for many years to come.

Until this issue is resolved, the gold price is likely to remain strong, as in this environment, it’s a more attractive asset to hold than paper money.

All Australians would benefit from getting some advice about investing in gold, the best way to own it and what it can do for your overall portfolio.

You can buy gold through retail superannuation (in ETF form only) if you are using the right super provider, or if you have a Self-Managed Super Fund (SMSF), you can actually buy and store physical gold (and silver) in your fund.

This process is no harder than buying shares on the stock exchange.

Times are tough out there. The Global debt crisis that we will struggle with for many years is in many ways more challenging than the problems which led to the Great Depression.

In times like these, saving and protecting your wealth should be of paramount importance.

Jordan Eliseo – Director of investments and advice