A hobbyist that collects gold coins is known as a numismatist. While some of these collectors might realize that gold coins can be a very good investment, that's not why they're collecting them.
A numismatic likes to collect coins because they are works of art. They are a lasting reminder of our history, and they are rare. Gold has been used in coins for thousands of years because gold has some very special metallic properties.
When our ancestors picked gold as the metal to be used in coins, they put a lot of thought into the selection process. It's always been hard to find, and rare items that are desired are usually valuable. That's the law of supply and demand at work.
It's also easy to work with, because pure gold, the 24 karat variety, is a relatively soft metal. That means it's malleable, so it can easily be stamped into a coin. Finally, gold does not oxidize (or rust) easily, and it does not dissolve, even in most strong acids. Our ancestors produced gold coins because the metal is rare, durable, and soft enough to stamp, or mint, into coins.
Individuals interested in gold coins have a choice to move down one of two paths. There are collectors that purchase coins because of their scarcity and beauty. While others buy the American Eagle, the Austrian Vienna Philharmonic, the Canadian Maple Leaf, and the South African Krugerrand as part of their investment portfolio.
This second type of investment, holding bullion, is a fairly common strategy used as a hedge against inflation. To understand why gold can be used as a hedge, it's critical to understand its use as an exchange rate standard.
Historically, gold was used as a universal exchange commodity. Between the years 1870 and 1914, there was a fixed exchange rate for gold throughout the world. That means the currencies of different countries (U.S. Dollar, Canadian Dollar, British Pound) were all linked to gold. This was known in the monetary world as the Gold Standard. By standardizing currencies, those participating countries could easily exchange goods and services, and the value of their currencies was relatively stable.
During the Bretton Woods Conference, gold was abandoned, as a currency standard and a set of complex rules were put in place to help stimulate international trade and maintain currency stability. World currencies were to be fixed to the U.S. dollar, which was also fixed to gold at $35 per ounce.
This fixed price was maintained until 1971, when international governments adopted a floating system. But the relationship between gold, the U.S. dollar, and monetary policy remains strong. This relationship is why gold can still be used as a hedge against inflation.
When inflation hits one country hard relative to another, the value of its currency is eroded. That's because the relative strength of the currency is diminished. It takes more of it to buy something from another country, which is not experiencing a high rate of inflation.
In the United States, when the dollar is weakening against other currencies, some investors will want to hold hard assets, such as gold. This is because all countries recognize the value of gold; therefore, the price should rise, in terms of U.S. dollars, with inflation.
In other words, just because the dollar is devalued by other countries, the value of gold remains constant in terms of their native currencies. This means gold will be worth more in terms of the dollar when it's weakening internationally. In this manner, gold acts as a currency hedge.
Investors understand the above relationship; so the price of gold often begins to rise even when inflationary times only threaten. Because investors are uncertain of the future value of paper assets they might be holding (for example, the stock of an American company), they look to gold's stability to ride them through these inflationary hard times.
Now that we've explained why investing in gold coins is so popular, especially during inflationary times, it's important to point out that coins are not the only way to invest in gold. Our article, Investing in Gold, walks through a number of options, including:
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