For new buyers of gold, fluctuations in the price of gold can be difficult to understand. It is essential for an investor to understand the reasons for a potential price change if any chance exists to make a profit on an investment.
All commodities, like stocks, wheat, precious metals and gold coins, have prices that are determined by the pressures of demand and supply. In the case of gold, there is the added pressure that hoarding of gold takes place by individuals and countries. This makes gold increasingly scarce and puts upward pressure on the expected value of gold. Gold is essentially an indestructible investment. Every ounce of gold mined on Earth is still physically viewable and able to be traded. When large amounts of gold are withheld from the market, gold prices rise because of a perceived increase in the scarcity of gold. The scarcity of gold is actually an illusion. Large amounts of gold can be turned loose on the markets at any time in unstable economic conditions.
Central Banks impact on the Price of Gold
The ability of national central banks to manage the gold they hold is one of the greatest price pressures on gold. This is because the amount of gold held by government institutions is larger than all the gold produced by mining throughout the world each year.
The possibility of large quantities of gold flooding markets of the world is why Australia, Europe, Japan and the United States have a ten year binding agreements, called the Washington Agreement on Gold. This agreement restricts any of those countries from selling more than 500 tons of gold per year. This agreement ensures that large amounts of gold remain in storage. Due to this agreement, gold prices have had a long period of steady increase and stability. The agreement is reviewed every ten years and the amount of gold that can be sold, by each country, was recently lowered to 400 tons per year.
The economies of India and China have been growing consistently. This has allowed both countries to buy and hold increasingly larger amounts of gold. These activities have withdrawn large quantities of gold from the market, causing prices to rise.
Other events that create economic uncertainty can also have an impact on the price of gold. Some of these events are as follows.
- Bank failures can affect gold prices.
- Long periods of low rates of interest, on other types of investment, can cause investors to hold gold.
- Events of terrorism or governmental instability are always a reason for pressure on the value of gold.
These events cause citizens to lose faith in the currency of their own country. Whenever uncertainty or instability increase beyond a tolerable level, people turn to gold, and keep it, as a relatively safe-haven investment.
Countries with strong banking systems and deposit insurance schemes for bank deposits tend to be stable. This helps keep the price of gold relatively constant in those countries. If the citizens believe the value of their local currency is safe, they will sell gold, putting downward pressure on gold prices. When banks start to fail or are caught not conforming to government standards or regulations, the price of gold may rise.
Events that cause downward pressure on gold prices are new gold discoveries, sales by large countries and prohibitions placed on citizens on their ability to hold gold. When economies are robust, gold prices may drop. This is because other investments are more liquid and easy to convert to local currencies. This is why often, when the stock market rises, gold prices may decline.