What is... | December 22, 2009

What is influencing gold prices?

Gold has been a rare and gleaming asset in some investors' portfolios during the downturn. But the price of gold can move quickly. Why did the price of gold reach such highs? And what factors can contribute to it rapidly falling at other times?


As good as gold
Gold is a valuable commodity but is used for a limited number of practical purposes. It is used in jewellery - which made up 62% of the 2008 supply according to World Gold Council data - and electrical components and dentistry - 12% of the 2008 supply. The rest - or about 26% - was involved in investment.
The price of gold hit a record high of US$1,896.50 per ounce on 5 September 2011. But by April 2013, it had fallen to less than US$1500, a drop of about 20%.

Demand is not the only reason the gold price is high
Conditions in financial markets are a major driver of the gold price. The commodity is often seen as an alternative to currencies such as US dollars or euros. While it would be unusual to settle your shopping bills in gold bars, the metal can be an alternative way to hold spare cash. During the global financial crisis, investors worried about the stability of banks and about returns from other types of investments. Gold became more popular among professional investors because it provided a safe way to store wealth. According to the basic economics of supply and demand, the price of gold was pushed up. In the recovery, this pressure dropped and other factors became more relevant. These include:

  • Very low interest rates: A downside of gold is that it does not usually accrue interest, unlike currencies. But with the interest rates very low, there is little interest lost by holding money in gold rather than in a currency.
  • Fear of inflation: Some investors fear the central banks are printing too much money and are worried it will lead to high inflation and cut currencies' purchasing power. Gold is attractive to investors who fear increased inflation.
  • US dollar weakness: The fall in the US dollar increased the price of gold in dollar terms.
  • Speculation: With the price of gold generally rising over the past year, some investors buy it to make a quick profit and push up the price in the short term.

The future is not necessarily golden for the precious metal
Opinion is often divided about what will happen to the price of gold. Pressures that could see the gold price fall in the future include a strengthening US dollar, stable inflation and rising interest rates. Pressures that could see the gold price rise in the future include renewed weakness in the US dollar, further significant failures in global financial institutions and a sharp and sustained increase in inflation. Speculation will continue to play a major role but its influence cannot be long lasting.
Former International Monetary Fund chief economist Kenneth Rogoff wrote in 2010 when the gold price was rising strongly that "most economic research suggests the gold price is very difficult to predict over the short to medium term, with the odds of gains and losses being roughly in balance".

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eZonomics team
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