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What are the factors which influence the price of gold?

    IndianMoney.com Research Team | Monday, February 09,2009, 03:50 AM
 

Among all the precious metals, gold is the most popular as an investment. Investors usually buy gold as a hedge or safe haven against any economic, political, social, or currency-based crises. These crises consist of investment market declines, inflation, war, and social unrest. Investors also buy gold during times of a bull market to financially gain.

Gold price

The general benchmark for the price of gold is known as the London Gold Fixing, a twice-daily (telephone) meeting of representatives from five bullion-trading firms. In addition there is active gold trading based on the intra-day spot price, derived from gold-trading markets around the world as they open and close throughout the day.

Factors Influencing the Gold Price

Today, like all investments and commodities, the price of gold is finally driven by supply and demand. Unlike most other commodities, the hoarding and disposal plays a much bigger role in affecting the price, because most of the gold ever mined still exists and is potentially able to come on to the market for the right price. Given the vast quantity of stored gold, compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production.

According to the World Gold Council, annual mine production of gold over the last few years has been nearer to 2,500 tonnes. Around 3,000 tonnes goes into jewelry or industrial/dental production, and around 500 tonnes goes to retail investors and exchange traded gold funds. This translates to an annual demand for gold to be 1000 tonnes in surplus over mine production which has come from central bank sales and other disposal.

Central banks and the IMF play an important role in the gold price. At the end of 2004 central banks and official organizations held 19 percent of all above-ground gold as official gold reserves. The Washington Agreement on Gold (WAG), which dates from September 1999, restricts gold sales by its members (Europe, US, Japan, Australia, Bank for International Settlements and the International Monetary Fund) to less than 400 tonnes a year. European central banks, such as the Bank of England and Swiss National Bank, have been key sellers of gold over this period.

Although central banks do not usually announce gold purchases in advance, some, such as Russia, have expressed interest in growing their gold reserves again as of late 2005. In early 2006, China, which only holds 1.3% of its reserves in gold, declared that it was looking for ways to improve the returns on its official reserves. Many bulls hope that this signals that China might reposition more of its holdings into gold in line with other Central Banks. A 500,000,000,000 (500 billion) Yugoslavia dinar banknote around 1993, the largest nominal value ever officially printed in Yugoslavia, the final result of hyperinflation.

In general, gold becomes more desirable in times of

  • Bank failures
    When dollars were fully convertible into gold, both were viewed as money. Though, most people favored to carry around paper banknotes rather than the somewhat heavier and less divisible gold coins. If people feared their bank would fail, a bank run might take place. This is what happened in the USA during the Great Depression of the 1930s, important President Roosevelt to impose a national emergency and to outlaw the hoarding of gold by US citizens known as Executive Order 6102 which has since been ended.
  • Low or negative real interest rates
    If the return on bonds, equities and real estate is not sufficiently compensating for risk and inflation then the demand for gold and other alternative investments such as commodities increases. An example of this is the period of Stagflation that took place during the 1970s and which led to an economic bubble forming in precious metals.
  • War, invasion, looting, crisis
    During national crisis, people fear that their assets may be seized and that the currency may become worthless. They view gold as a solid asset which will always buy food or transportation. Thus in times of great uncertainty, mainly when war is feared, the demand for gold rises.

Reasons for Investors Buying Gold

Investors usually buy gold for two main reasons: to financially gain from increasing gold prices, and/or as a hedge or safe shelter against any economic, political, social or currency-based crises.

Methods of investing in gold
Investment in gold can be either done directly through bullion or coin ownership, or indirectly through certificates, accounts, spread betting, derivatives or shares.

Investment strategies

Fundamental analysis


Investors using fundamental analysis examine the macroeconomic situation, which includes international economic indicators, such as GDP growth rates, inflation, interest rates, productivity and energy prices. They would also analyze the total global gold supply against demand. Over 2005 the World Gold Council estimated total global gold supply to be 3,859 tonnes and demand to be 3,754 tonnes, giving a surplus of 105 tonnes. While gold production is unlikely to vary in the near future, supply and demand due to private ownership is highly liquid and subject to rapid changes. This makes gold very dissimilar from almost every other commodity.

Gold versus stocks


The ratio of the Dow Jones Industrial Average index divided by the price of an ounce of gold. A substitute index was used to generate all points before 1897.

DJIA in Gold


The performance of gold bullion is frequently compared to stocks. They are essentially different asset classes. Gold is a store of value whereas stocks are a return on value (i.e. growth plus dividends). Stocks and bonds perform best in a steady political climate with strong property rights and little turmoil. Since 1800, stocks have constantly gained value in comparison to gold due in part to the stability of the American political system. This approval has been cyclical with long periods of stock outperformance followed by long periods of gold outperformance. The Dow Industrials bottomed out a ratio of 1:1 with gold during 1980 and proceeded to post gains throughout the 1980s and 1990s. The ratio went high on January 14th, 2000 a value of 41.3 and has fallen sharply since.

In November 2005, Rick Munarriz of Motley Fool.com posed the question of which signifies a better investment: a share of Google or an ounce of gold. The exact comparison between these two very different investments seems to have captured the imagination of many in the investment community and is serving to crystallize the broader debate. At the time of writing, a share of Google's stock and an ounce of gold were both near $700. On January 4, 2008 23:58 New York Time, it was reported that an ounce of gold outperformed the share price of Google by 30.77%, with gold closing at $859.19 per ounce and a share of Google closing at $657 on U.S. market exchanges. On January 24th 2008, the gold price broke the $900 mark per ounce for the first time. The price of gold topped $1,000 an ounce for the first time ever on March 13, 2008 amid recession fears in the US. On September 21, 2008 gold closed at $862 per ounce while Google closed at $449.15. On November 26, 2008 gold (NY spot) closed at $806.10 per ounce while Google closed at $292.09.

Technical analysis


As with stocks, gold investors may support their investment decision partly on, or solely on, technical analysis. Classically, this involves analyzing chart patterns, moving averages, market trends and/or the economic cycle in order to speculate on the future price.

Using leverage


Bullish investors may opt to leverage their position by borrowing money against their existing gold assets and then purchasing more gold on account with the loaned funds. This method is called as a carry trade. Leverage is also a vital part of buying gold derivatives and unhedged gold mining company shares. Leverage by means of carry trades or derivatives may increase investment gains but also increases risk, as if the gold price decreases, the investor may be subject to a margin call.

In 2008, ETF Securities launched ETFS Leveraged Gold (LSE: LBUL) which is intended to change each day by twice the daily percentage change in the DJ-AIG Gold Sub-Index (before fees and adjustments). Therefore if the DJ-AIG Gold Sub-Index increases (or decreases) by 1% in one day, then ETFS Leveraged Gold will rise (or fall) by 2%.

Bulls versus bears


Since April 2001 the gold price has more than tripled in value in opposition to the United States dollar, prompting speculation that the long secular bear market (or the Great Commodities Depression) has ended and a bull market has return. In March 2008, the gold price reached above $1000 before falling under $800, which in actual terms was still well below the $850 peak in 1980. In the last century, major economic crises like the Great Depression, World War II, and the first and second oil crisis lowered the Dow/Gold ratio substantially, in most cases to a value well below 4. During these difficult times, investors tried to defend their assets by investing in precious metals, most notably gold and silver.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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