The global demand for gold in 2020 was 3,759.6 metric tons which was a significant decrease from 4,386.4 in 2019 that was observed in the preceding years. The average price in 2020 was $1,850/oz while in 2029 it was $1,393.
So, for those of us who are constantly hearing this new hype in bullion investments with the rise of cryptocurrency, these statistics might be difficult to understand. This is partially because a general layman’s perspective about gold is primarily related to its stagnant value. However, we have seen and still continue to see fluctuations in the demand and supply that correspond with the price of the precious metal. This directs one’s interest to one question: what are the factors really influencing the price of gold?
Starting with the classics of economic theory: inflation. The notoriously known fact about precious metals like gold is that they prove to be a great store of value owing to the fact they are rare and scarce in supply. Generally, inflation tends to devalue a currency. By virtue of this fact, assets like gold (termed “real assets”) serve as a hedge against inflation. Even when the currency devalues or fluctuates, gold is expected to hold its value. The purchasing power of an ounce of gold is mostly stable regardless of the economic environment. Focusing through the same lens, the demand for commodities such as gold increases as inflation rises. This increases the price of gold. Moreover, gold’s value is stable outside the political environment leading it to be a decent low-risk investment regardless of flailing currencies. Hence, when there are concerns about the value of paper money, investors keen interest in gold only grows.
Similarly, the value of the U.S. Dollar plays a significant role in affecting prices. As the leading, most dominant world currency that is used by most countries for international trade, any fluctuations to its value have global consequences. Gold and the U.S. dollar share an inverse relationship whereby a stronger value of the dollar means gold is weaker, and vice versa. This is exhibited by the rise of the U.S. dollar index by 2 points during the time period of September 1-10 in 2014 which lead to the softening of the gold market- more people wanted to sell gold than buy. On the flip side, a strong dollar attracts more buyers as the investment opportunities and consequent benefits are high.
This yellow metal is frequently referred to as a crisis commodity; when people’s confidence in their governments is turbulent and financial markets are unstable, the price of gold is inclined to rise. Because gold is considered to be a source of safety during economic difficulties and geopolitical tensions, changes in gold prices naturally have a direct relationship with world events. To demonstrate, examples of the Gulf War I and Russia-Ukraine tensions can be used. The start of the Gulf War softened the gold price while the moving of Russians into Ukraine rose the gold prices as people became more unsure about the geopolitical situations that would unwrap, hence, buying more of the yellow metal for security. Simply put, political chaos increases investments in gold as a safe haven.
Similarly, instability in central banks also pushes people to buy gold as a safe haven. In the United States, the federal reserve is the central bank. Other countries might have central or rather dominant banks like the Swiss National Bank, the Bank of Japan, and the European Central Bank. People turn to gold when the paper money goes through periods of uncertainty potentially caused by bank failures or economic chaos. This is closely related to the tangible security gold bullion provides, attracting investors. As a result, an increase in demand raises the value of gold further up.
Gold prices more often than not display the increases and decreases in interest rates as they share an inverse relationship. Because a fall in interest rates does not ensure a good return on deposits, they invest in buying gold instead as the opportunity cost of carrying gold is lower than other investments. Likewise, gold prices tend to soften as people move towards selling it for other investments when interest rates increase.
Quantitative Easing is another factor i.e. when the central bank purchases securities from the open market in order to increase the money supply. These banks are encouraged to loan more money increasing the money supply. When done cautiously and in limited ways, an expanded money supply attracts investments in gold owing to the lower opportunity cost. Inflation caused by money supply may also raise the price of the precious metal.
Government reserves consist of both paper money and gold. Apart from the United States, countries like France and Germany also hold gold in the reserves. At times these central banks start purchasing gold in bulk. Because more of it is bought than sold it becomes more scarce while currency supply increases hence the price of gold is pushed upwards.
Gold jewellery is rather popular as a safe haven investment with increased demand from countries like India where it is also of cultural significance- used as a show of wealth, gifts, and in some parts still used as a form of currency. This increased demand from India followed by China and the USA also affects the price.
Moreover, the supply of gold does not equal its production. An increased production comes with increased costs and a higher need for miners to obtain profits raising the gold price globally.
Following on from this, the bottom line is that the economic laws of demand and supply are at play here too. An increase in demand regardless of the reason, be it economic instability or money supply, will increase the price and vice versa follows. Meanwhile, in the long run, the value of gold remains stable.