How these Factors Influence Gold Prices
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According to Reuters, the relationship between gold and inflation has been quite weak for the past fifty years. The study also suggests that back in the 1980s, inflation reached 15% in the United States and gold hit a record high of $666.75. Even after the 80s, gold never reacted that strongly in the face of price pressures.
While we do agree that gold is a hedge against inflation, we need to see why this happens. In this post, we’ll discuss common factors that determine the price of gold at a given time.
The value of the US Dollar
The US dollar is undeniably one of the most dominant currencies in the world. Most countries in the world measure their exchange rate against the dollar. It is also the most common international medium for transactions.
The US dollar also provides price support to gold. When the US dollar loses its value, gold appreciates. This is because it becomes cheaper to buy in other countries.
The demand for gold, therefore, increases in other countries owing to lower comparative prices. This theory applies to countries that compare their currency value to the US dollar to determine commodity prices.
The role of the central bank
While the Ministry of Finance drafts fiscal policy, it is the central bank’s job to devise monetary policy. The main component of monetary policy is interest rates. This directly and indirectly affects all other rates that prevail in the market—including gold prices.
When the Federal Reserve’s raises the interest rate, gold prices depreciate—and vice versa. When interest prices increase, investors sell gold to free funds to be able to invest them elsewhere.
Naturally, all investors want to take advantage of rising interest rates and invest in securities whose value is determined by interest income. Similarly, when interest rates decrease and interest-bearing securities are no longer profitable, investors sell those securities and revert to gold.
Psychological factors have a huge role to play in determining the prices of all investment securities. If the geopolitical conditions are deteriorating and the government is going through turmoil, it’s natural for investors to get worried.
Historically, when citizens lose their trust in the government, they sell off every security that’s affected by government policies. These include government bills, stocks, and bonds. Gold, on the other hand, is not directly affected by the policies of the governments or the political circumstances. Therefore, gold is rarely affected by a change in government faith.