Investors may find sometimes gold really complex. Positively correlated with the excess of money supply, but negatively to changes in exchange rates of major currencies, it draws investor demand, central banks and jewelry sector.
Some actors demand benefit when economies grow while others benefit when economies contract.
In this article, we provide a more nuanced picture, more realistic and helpful which varies the price of gold.
The apparent complexity of gold should not deter investors.
Gold is a global asset, interconnected to many factors and many markets. Investors should not be discouraged by the apparent complexity of the price of gold or influenced by theories that minimizes its multifaceted appearance. On the contrary, the dynamism of the gold market supports some of its most relevant qualities : low correlation with other assets, store of value and performance during periods of uncertainty.
The standard way to evaluate a « commodity » does not work on gold. Being a rare material, it is estimated the quantity of physical gold worldwide to 177 000 tonnes (about 8 trillion). Some reservations are not ready to return to the market, but some part of physical gold is exchanged and gives the gold market very liquid in appearance.
Gold doesn’t pay over-interests because its a real asset.
Many investors believe that gold has no real return, it has no value. Nevertheless, it is common misunderstanding. Gold has no real performance because it is a real and tangible assets. It is like a coin but which is trading for over 5000 years. The US dollar has no returns. The cash deposits in banks, bonds, etc … are the underlying assets benefiting from interest in return.
Those who focus on one factor of influence when analyzing the price of gold and its market forget the importance of other factors that weaken or possibly cancel the only factor on which we had previously based .
Many commentators news channel on the stock exchange tend to offer the same explanation to explain the performance of the price of gold: its relationship to US Dollars and US interest rates. US variables are important because the United States have a significant role in global finance. Since the collapse of the Bretton Woods agreement in the 1970s, the dollar maintained an opposing relationship with gold. Firstly the market is global and the demand for physical gold from emerging markets account for 70% of global demand today as US demand for gold now represents less than 10%. And these units are not all related to the investment.
All theories related to too high of US indicators to explain the price of gold should therefore be taken with consideration.
6 factors that drive the gold price.
- Currencies : Although gold is no real support for the exchange rates, it has all the characteristics of a currency. It is established as a unit of exchange and traded in a very liquid market. Negatively correlated with the dollars and used as a store of value in countries where exchange rates are volatile, the amount of gold stocks, however, may only increase with the output of mines, which contrasts with fiat money which can be freely created. This helps investors protect against purchasing power declines.
- Inflation / Deflation : the variables such as inflation have a profound impact on how investors see gold. Inflation and deflation expectations dictate the level of purchasing power, and high inflation can be very disruptive and meaning and impact on gold demand. The effect of these two factors on the price of gold should be observed not country by country, but globally. In addition, gold performs better than other assets during deflationary periods.
- Interest rates : they are key components on the evaluation of financial assets because they measure the opportunity cost of keeping money in cash by the others. High interest rates may increase the opportunity cost of investing in gold. But the economic environments in which they grow
- Consumer spending and rising incomes : jewelery, bullion, coins and technological applications are the majority of the demand for gold. The increase in disposable income and aggregate consumption encourages the purchase of products mentioned above. As the economies of emerging markets, high levels of wealth will increase demand in gold.
- Crisis risks : during periods when the risk of financial and economic crises are present in the markets, investors are looking for highly liquid assets like gold. These types of events do not appear regularly and are difficult to predict, but can have a devastating effect on the wealth of investors. Gold stood out as an aid to investors losing much in these situations there. The circumstances of these systemic risks may change the risk tolerance of investors, and thus the management of their strategy and their portfolios by diversifying their assets to gold for example.
- The supply factors : the above factors relate to the motivations to buy gold. On the other side, the supply used to meet the gold purchase request is also a factor that influences the price of the precious metal. The offer may come from mine production or recycling. Supply-side tensions may well increase the gold and result in shortages and pushing up the price of gold to buyers being willing to pay more to get them.
Source : Gold Investor vol. 8, World Gold Council