Gold prices have been hovering in and around all-time highs throughout this year. If you take a look at the charts, the price of gold has also risen considerably over the years to a point where it now trades at close to $2,000 per ounce. This is almost double what it traded at just five years ago. Considering this uptick in price then, you may begin to wonder, what actually drives the price of gold to make it such a valuable commodity.
We will take a closer look at the main factors which influences gold prices, and how gold has fared over the long-term when compared with some other investments.
Factors That Drive Gold Prices
Just like any other market, there are many things which can influence the price of gold. These can be fundamental in nature, and well as psychological, but they move the market nonetheless. Here is a detailed look at the major factors at play.
Referring to the impact of currency strength on gold prices is to more specifically acknowledge the influence of US Dollar strength on gold prices. Gold is priced globally in USD, and so, any move toward dollar weakness will increase the price of gold relative to other currencies.
The US Dollar and price of gold have an inverse relationship. This means that as the Dollar weakens, the price of gold rises, and vice versa. Also connected to this point, is that, when the Dollar is weaker, it increases the amount of gold which can be purchased with another currency. This tends to increase demand, and therefore the price also rises. This point is evident in 2020 as we see rising gold prices amid a falling US Dollar.
Government fiscal policy can be a big determinant in the value of gold, and certainly work to drive it in either direction. The major tool of monetary policy which is at work here, are interest rates.
Very basically, a consistently low interest rate could see yields from traditional forms of investment fall below a certain acceptable level to investors. With lower potential returns in one area, investors are pushed toward other areas to achieve higher returns. Gold markets are often the places where investors flock to in these situations. Similarly, if the indication is given of raising interest rates, the price of gold tends to suffer as investors move out toward more interest correlated markets.
Inflation or Hyperinflation
Typically viewed and talks about as a “hedge against inflation”, gold prices tend to rise in tandem with inflation in the economy. This is often due to the fact that increasing inflation is a signal or economic growth, and is often accompanied by an increasing money supply.
Any increase in the money supply essentially dilutes the value of a paper currency, making it more expensive to own safe-haven commodities like gold. This factor is also interwoven with other points of fiscal policy since increasing inflation can also typically be a by-product of low interest rates, and accompany a drop in US Dollar value.
Hyperinflation is a term to describes an overproduction of the printing of currency which results in excessive, and out-of-control general price increases in an economy.
Supply and Demand
Due to the fact that the amount of held (already mined) gold, vastly outweighs the new supply at any given time, the supply and demand factor is often overlooked with many pointing out that gold is not impacted in the same way as other markets in this respect. That is true to an extent, however, the global demand can still have an influence on the price.
Gold is of course a big feature of the jewelry industry as well as being very much in demand within the electronics sector. An increase in demand from these areas will see an increase in gold prices at least a certain amount, and vice versa.
The overall economic environment globally can have a significant impact on gold prices. This factor really encompasses many elements of all the prior factors mentioned. Gold is above all, perhaps the number one safe-haven asset in the world. This means that in times of uncertainty economically, people move strongly toward buying gold.
Naturally, this creates a rush in demand, which can lead to a spike in the price. This is the overriding factor which has led to the 2020 increase in gold prices since many investors are faced with an economic uncertainty ahead.
Risks to Buying Gold
As with investing in any market, there are always some risks to take into consideration. These same factors which act to drive gold prices higher, can reverse and have the same impact on the downside.
Looking back over the years though, gold returns have been extremely consistent. The commodity has had good and bad years, though it tends to provide a steady rate of return which has certainly…
Read More: What Makes Gold So Valuable?