The price of gold is driven by several important factors. While it may seem complicated, knowing these factors will help to demystify investing in gold. Investors should also know that factors like supply, demand, and market sentiment, can work both independently and together to shift the price of gold. Many investors believe that investing in gold is similar to investing in currency. These two however, are very different.
With paper money or fiat currency, the value is directly affected by the amount that exists. If more paper money is printed, the value will go down and vise versa. While the same is true for gold, the supply and demand are different. The amount of gold mined per year is very stable, meaning that supply is not the largest contributor to gold prices. The differences between gold and the dollar mean that investors often turn to precious metals as a way to avoid inflation.How Inflation Affects the Price of Gold
Several studies done in the past two decades have shown that the correlation between gold and inflation is low. That means that when inflation goes up, gold prices can stay relatively stable. What we do know is that when economic troubles hit the market, investors tend to put their money into gold. This has historically risen the price of gold.
For example, when the recession hit in 2008, the price of gold went up to almost $1000 an ounce before shifting back to around $800. A few years later in 2011, gold hit a high of almost $2,000. Analysts have concluded that gold has a positive price elasticity. For those who are not familiar with economist jargon, this simply means that when more gold is bought, the price will go up. Or in other words, demand correlates positively with the price of gold.Does Supply Affect Gold Prices?
While other resources can be consumed or utilized, gold stays in its original form. The gold that is mined, is either used for investment purpose, jewelry, electronics, or other uses. This means that the supply is constantly going up no matter how much gold is being mined. One would assume that this would mean the price would go down, but it’s a little more complicated than that.
While a lot of gold is circulated around the market, a lot of gold is taken out of circulation by those who hold on to jewelry or don’t touch their gold investments. It appears that the price of gold affects demand more than the supply does.One of the Biggest Factors for Gold Prices
One of the largest drivers of price changes for gold is central banks. When countries have large supplies of gold on hand, economies will be in relatively good shape. This means that the banks do not need to have as much gold, and will often lower the amount that they have on hand. This is because central banks see gold as an unmoving asset, or one that does not have a high amount of investment potential.
But, when central banks sell off their gold, the price will undoubtedly fall. This means that these banks have a major amount of play in the gold industry. For this reason, there are worldwide agreements that do not allow banks to offload more than 400 tons of gold in one year. But, this is also to safeguard the banks own investments, as a lower price of gold would be bad for them as well.Investing in Gold Stocks and ETFs Drives Prices
While central banks can play a big role in the price of gold, ETFs themselves can also shift prices. Gold ETFs which include SPDR Gold Shares (GLD Price) and others, offer investors the opportunity to buy shares of gold, without having the risk that mining stocks may hold. These ETFs trade on normal stock exchanges and anyone can buy them. The purpose, however, is to offer exposure to the price of gold without the ETF affecting that price.
If investing in gold is your MO, there are several things to know. If one wants to bet against inflation, gold may not be the best choice. But, if one is looking to diversify their portfolio, gold may in fact be a solid way to do so. Most people who are buying gold, are doing so as a store of wealth rather than a bullish investment. The price of gold has stayed relatively similar in the past four decades. Stability however, should not be overlooked as it is an important factor to consider for investing.The U.S. Dollar’s Effects on Gold Prices
Analysts have time and time again shown that the price of gold is affected inversely by the value of the U.S. dollar. This means that when the dollar goes up in value, the price of gold goes down. This is because confidence in the dollar means that investors are usually looking for growth rather than stability.
On the contrary, when the value of the dollar goes down, investors want to retain their wealth by buying and holding gold. This is why so many investors choose to buy gold when geopolitical events occur. This is an important factor to keep in mind, and one that investors should utilize in their portfolios.The Effects of Retail Gold Use on the Price of Gold
Last year, studies showed that using gold in jewelry accounted for almost half of the worldwide demand for gold. In 2019, that amounted to around 4,400 tons of the shiny substance. Around the world, China, India and the U.S. are the largest buyers and consumers of gold. Around 7% of the other use of gold is attributed to technology or using gold for industrial purposes.
Gold is used in a wide range of products including computer circuit boards and medical devices. This means that the price of gold can be affected both positively and negatively by its usage in technological and industrial devices. Although this is a small percentage of the total gold consumed, it is definitely a factor to consider.Gold as a Method to Store Wealth
As mentioned above, when recessions hit, investors turn to gold. This is because gold can be a very stable store of wealth. When the economy takes a turn for the worse, traditional investments like real estate, equities and bonds, often fall in value as well. But, the price of gold usually continues to stay quite stable.
In addition, the price of gold can actually increase during times of economic turmoil. This is true around the world as gold can be a way to protect ones wealth from decreasing based on currency devaluation.Does Gold Production Affect the Price of Gold?
The largest producers of gold in the world are the countries of China, South Africa, the U.S., Russia, Australia and others. These countries together produced around 3,600 tonnes of the yellow substance in 2018. That production amount has continued to increase over the course of the past decade. But, in the past three to four years, the amount of gold being mined yearly has not increased substantially. This is due to several factors.
For one, gold is getting tougher to mine. The more we pull out of a mine, the deeper we have to go to find more gold. This means that it is becoming more challenging every year to extract gold across the world. In the past few years, this has meant that producing more gold is getting more expensive. This can actually increase the price of gold as the cost of mining increases.What This All Means
Gold has for thousands of years, been a valuable asset. Dating back to ancient Egypt and beyond, people have used gold to buy and trade goods. In 2020, that sentiment has largely remained unchanged. While people may not be trading gold to buy spices or livestock, investors are still using gold as a store of wealth.
All of the above factors are small parts of a much larger industry. But as we can see, there are a myriad of factors that can affect the price of gold. Whether investors are looking to avoid inflation, stabilize their investments, or diversify their portfolios, gold may just be the right choice after all.