Gold is one of the most valuable commodities in the world. Many investors turn their eyes towards gold during an economic downturn or geopolitical issues. While gold is considered less volatile with lower risk compared to other investments, it can be difficult to understand its prices.
Bloomberg's Ben Bernanke, the former chairman of the Federal Reserve, once told the US Congress that "nobody understands gold prices, and I don't pretend to understand them either." If one of the most respected bankers in the world can't understand gold prices, you shouldn't blame yourself for it either.
Though it can be a challenging task to predict the gold's value in the short run, there are some factors that you need to consider. These factors can be crucial in giving you a baseline understanding of the gold's value. But before we move on towards these factors, let's look into the overall quantity of gold in the world.
How Much Gold is There?
Various experts believe that approximately 120,000 - 150,000 tonnes of gold are above the ground. Furthermore, every year, companies mine 3,200 tons of gold. According to the World Gold Council, most of the gold is recycled yearly to meet the high demand.
The gold produced is usually used by various industries for jewelry or dental purposes. However, substantial gold goes to investment products such as coins, bullion, or gold ETFs (Exchange Traded Funds). Central banks are the largest buyer of this precious commodity.
It is a vital point to remember since demand and supply are critical in driving gold's price. You might wonder what other things can impact the price of gold and its demand. Let's go over some major factors influencing this precious metal's price.
4 Factors that Determine the Price of Gold
While other factors can drive gold prices up or down, these are the most common ones. Getting a better idea about these factors will help you create a robust investment strategy.
1. Value of the US Dollar
Since gold is priced and traded in US dollars, any change in the currency will likely affect its price. To put it in simple words, a stronger US dollar will keep the price low. On the other hand, if the US dollar is weaker, the price of gold will likely increase.
So, gold investors should keep a close eye on the US dollar. Economic uncertainty and concerns about recession will weaken the US dollar, driving the prices of gold up.
But, if there is a positive outlook for the US economy with stable job growth and high consumer confidence, the price of gold will stay low. Since many consider gold a great investment opportunity, people will invest in it if there is economic uncertainty or political instability.
2. Central Banks
A Central Bank plays a critical role in managing the country's economy. It evaluates the monetary policy, changes in interest rates, controls the money supply and tries to control inflation. In the past, many western nations have backed and tied their currency to gold.
But, the majority of the economic experts believe that these efforts didn't work. Nevertheless, central banks around the world hold gold reserves, including economies like the US. The United States has the largest reserves of gold in the world, with more than 8,000 tonnes.
So, why does the US continue to buy gold? Mainly due to the relationship between the US dollar and gold. They have an inverse connection, making gold a hedging instrument against the US dollar. Various central banks or countries hold gold reserves since it is a tangible asset tied to their currency.
Currently, the two buyers that have recently purchased more gold include China and Russia. According to the IMF (International Monetary Fund) and Bloomberg, both countries have significantly increased their buying of physical gold after the financial crisis.
3. Inflation
Another major driver of gold prices is inflation. Many countries and investors purchase gold since it is the best solution to deal with inflation. Gold's history shows how investors use it to hedge against inflation. Therefore, if inflation is rising at a rapid rate, you can see an increase in the gold price.
Market studies show how inflation is the best indicator to know about the changes in gold prices. You can learn about the inflation rate and then make your investment strategy accordingly.
Consider it to be a buying power of the dollar. If we compare gold's buying power, it remains strong against the dollar in the last four decades.
4. Industrial and Commercial Purposes
Finally, the demand for gold due to industrial and commercial purposes can also affect its prices. Around 50% of the annual production of gold globally goes towards jewelry and other accessories. The two bigger consumer markets that account for the majority of gold jewelry include India and China.
Since the supply is limited, an increase in demand will push gold prices up. Conversely, if the demand decreases, then gold prices will also go down. So, keeping an eye on the changing demand and supply trends is essential when you're keeping its price changes in mind.
In addition to jewelry, various other industries also use gold in their processes. The gold's optimal thermal and electrical conductivity properties make it an integral component of various industrial purposes, including pharmaceuticals.
The bacterial colonization and robust resistance to corrosion make it especially vital for the medical industry. Additionally, gold is essential in producing critical elements of TVs, PCs, and other electronics that store data.
Brief History of Gold Prices
Before you invest in gold, you need to know about the asset's historical price trend. It will give you an idea of the events or factors that led to a drastic rise or fall in its prices. Here is an analysis of the change in gold prices over the last five years.
- 2018: The gold had touched the lowest value of $1,178 while going as high as $1,355 in 2018. Changes in the interest rates by the US Federal Reserve helped the dollar gain strength. As a result, gold prices saw a drastic fall by 2018.
- 2019: The gold prices touched their highest value of $1,546 due to concerns of global recession and the US dollar weakening. Gold prices touched the highest value in the last five years in 2019.
- 2020: Gold prices reached the highest value of $2,067 in 2020. Due to the Covid-19 pandemic, investors turned toward this precious commodity. As a result, gold prices reached an all-time high.
- 2021: The gold prices saw a decline in their value as economies started opening up, which strengthened the dollar. It reached the highest value of $1,943 while going as down as low as $1,684 in 2021.
- 2022 (Year to Date): The gold's value touched the $2,000 mark again due to geopolitical issues, high global inflation, and concerns about a global recession.
These historical price analyses give you an idea about the changes in the gold price in the last five years. You can learn about the factors that were behind these price fluctuations to keep an eye on future trends. Keep these factors in mind and then make an investment strategy for investing in gold.
Why Should You Invest in Gold?
Investing in gold comes with various benefits. If you look at other investments, such as stocks, gold offers better returns for investors. The best thing about gold is that it is relatively stable compared to other investment opportunities. As a result, it has become a top pick among investors who want a good ROI in the long run.
The best thing about investing in gold is that it protects your money against inflation. The price of gold will appreciate, allowing it to retain its purchasing power that would have been lost in the form of cash. Moreover, it is a good way to save money for the future. Here are some other benefits of investing in gold:
- Acts as collateral against loans
- Diversifies your portfolio
- Easy to liquidate this commodity
- Easy to pass on to the next generation
- It doesn't depreciate or deteriorate over time
- The price is relatively stable compared to stocks, real estate, etc.
- You don't have to spend too much money on maintenance
Investing in Gold
We hope you now have a better idea about the potential drivers of gold's price. Having a firm grasp on these factors will help you understand the price fluctuations and changes in gold's price. You can keep a close eye on it to create a long and short-term strategy accordingly.
Gold can help you diversify your portfolio, especially if you have investments in volatile commodities. Many financial experts and advisors suggest that physical gold and silver can be great assets to invest in. These precious metals can act as a hedge when other investments are volatile.
Ideally, the investment strategy for any commodity would be to buy low and sell high. However, precious commodities like gold and silver will give you optimal returns if you invest in them in the long run. For various reasons mentioned in this article, many factors drive the price of gold up, so there is no way to tell when it's best to buy or sell.
