What or who determines the price of gold? What you should know

Today, gold is highly coveted, but not for the usual reasons, ie jewelry design or as an investment method. And it is that, gold has become an essential material for the manufacture of certain electronic devices and medical equipment or implements. In fact, gold, as of March 2020, was positioned at $1,625 per troy ounce, which represents a considerable increase, at least when compared to $300 per troy ounce 50 years ago. But, what or who determines the price of gold? What makes it go up or stay so stable? Why is it said that investing in gold is a good option in the long term? Let’s see it!

Let’s talk about Central Bank reserves

Central banks have two main functions: 1. to issue paper money and 2. to accumulate gold in their vaults as reserves. As central banks diversify, their monetary reserves in gold (far from the paper currencies they have accumulated) tend to increase, since the value of this precious metal always rises over time, beating even inflation. Many nations of the world continue to hold the majority of their reserves in gold instead of using other strong currencies, such as the dollar or the euro.

About, Bloomberg has stated on previous occasions that the different central banks around the world are buying as much gold as they can, especially since the United States abandoned the gold standard in 1971.. Of all, Russia has been the largest buyer. This is followed by countries such as Turkey and Kazakhstan. In total, it is estimated that the world’s governments bought about 651 tons of gold in 2018 alone.

What or who determines the price of gold?

The relationship between gold and the value of the US dollar

The price of gold is generally inversely related to the value of the United States dollar. This is mainly because its price is usually represented in dollars. Therefore, if the US dollar has a strong presence in the market, this will translate into a lower and more controlled gold value.

If the US dollar loses credibility and becomes weaker, then this will automatically drive up the price of gold.. Speculatively, this surge (which doesn’t have to be that big) could trigger a gold rush, causing the dollar to weaken further against the precious metal.

For this reason, gold has been seen as a perfect hedge for inflation.. And it is that, although the levels of inflation are not so relevant in the United States, the more money you have, the more it could affect the investor.

An example

Think of a person who had $190,000 saved in the bank on January 1, 2019. US inflation for that year was 2.3%. If the investor leaves his money in dollars in the bank, as of December 31, 2019 I would have 2.3% less purchasing power, since the prices of global products and services would have increased due to inflation, right?

Now let’s look at the value of gold. On January 1, 2019, a troy ounce of gold was at $1,314.97 and closed the year 2019 (on December 31) at $1,527.57. This translates to a 16.17% increase.

If you think about it, if the person in our example had chosen to buy some of their saved money in gold, not only would he have protected himself from annual inflation, but he would also have made a profit. Now, in times of global crisis –like those of the COVID-19 pandemic– this difference could be seen even more clearly, as well as the tendency of investors to prefer investing in gold instead of participating in a highly volatile stock market or buying a currency -such as the dollar- that is losing strength due to the latest statements from the Fed.

Let’s try to see this point with a little more clarity. If the person in our example not only bought gold at the beginning of 2019, but held it to this day, the profits would be huge. Consider that 2019 opened with an ounce of gold at $1,314.97 and the spot price of gold just closed on July 29, 2020 at $1,968.84.

Impact of jewelry and the demand for gold at an industrial level

Only in 2019, the jewelery sector accounted for around half of global gold demand, which was calculated at a total of 4,400 tons according to the World Gold Council. India, China and the United States were the largest consumers of gold for jewelry, at least when measured in terms of volume.

7.5% of gold demand is attributed to technology and industrial use. And it is that, gold is used in the manufacture of mobile devices, computers and laptops; but also in the production of medical devices.

The price of gold, like that of all tradable goods in the market, is also influenced by supply and demand. As demand for consumer goods such as jewelry and high-end electronics increases, the cost of gold will rise.

Gold as patrimonial protection. It’s worth it?

In times of economic uncertainty – as seen in times of recession – more people turn to gold as an investment due to its stable and enduring value.. This increases demand and, of course, its price against the dollar. But why does this happen? Well, because gold is – for many years – what is considered “a safe haven” for investors, especially during the most turbulent and dark times of modern history.

When expected or actual yields on bonds, stocks, and real estate fall, interest in gold tends to rise. That is why it is said that gold is the almost perfect hedge against relevant economic events, such as currency devaluation or inflation. Additionally, gold is also considered to provide protection during periods of heightened political instability.

Tip: If you decide to buy gold as an investment, be sure to keep your bars, coins and ingots in your safe or in a security box at the bank of your choice.

Gold and demand in stock investments

The demand for gold can also be measured by evaluating certain funds traded on the stock exchange., being perhaps the SPDR Gold Fund (GLD) is the largest of them. To give you an idea, the SPDR Gold Fund had 915 tons of gold at the end of 2019. In total, gold purchases in various investment vehicles represent -approximately- 25% of the total demand, this according to the statements by the World Gold Council.

Note: While some investors prefer an ETF or Exchange Traded Fund, which is a stock document that shows that its holders are the owners of the metal; others opt for the purchase of shares in mining companies. Why? Because if the price of gold rises, they gain by 1. the increase in the value of the stock and 2. the increase in the price of gold.

What about the production of gold?

The main players in gold mining are currently China, South Africa, United States, Australia, Russia and Peru. The world production of gold also affects its price. This, of course, leads us to be, once again, spectators of the fulfillment of the law of supply and demand. Gold mining production in 2018 was estimated at -approximately- 3,500 tons. If compared to the tons produced in 2010 (2,400), anyone would notice the difference.

However, despite this significant increase, gold mining production has not changed since 2016, at least not in such a significant way. One of the reasons for its stability is that the “easy gold” has already been extracted. Today’s miners have to dig much deeper to access quality gold reserves.

The lack of accessibility of gold poses additional problems. Miners are exposed to more risks, this leaving aside the environmental impact of mining. In summary, obtaining gold today costs more than yesterday. Added to this are the production costs of the gold mine, which sometimes raises the spot price of the metal on the world market.

In short, what or who determines the price of gold?

Since ancient times, mankind has been in love with gold. When it began to qualify as an investment metal, the price of the metal was increasing considerably, something that you will be able to notice if you study its evolution in the last 50 years.

Like most of the products that are traded in the market, the supply and demand of gold worldwide are extremely important for the establishment of its daily price. However, it could be said that gold has an ace up its sleeve because it also retains an additional value.

It could be said that the government vaults and central banks of the different countries of the world represent an important part of the demand for gold, mainly because they continue to issue gold certificates and also because its economy is linked to the gold standard established by England more than 100 years ago.

  • Another factor that raises or influences the price of gold is investor demand, which is usually through ETFs.
  • The value of gold often goes against the value of the US dollar, because this metal is usually traded in dollars. This protects you from inflation.
  • The amount of gold extracted worldwide is mainly driven by mining production, which has stabilized since 2016.

Without a doubt, the desire to remain protected against inflation, the devaluation of a currency and any world crisis that impacts the economy also influences the price of gold.

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