5/17/2014 Factors Affecting The Gold Price

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Factors Affecting The Gold
Price
Gold can be a frustrating investment to own because at its root, its
a tough asset to value, and a lack of knowledge of where the gold
price is headed might put some investors off. In most markets,
there are plenty of fundamentals, reports, signals, and data that
can be used to get a good feel for the price of the asset. For
example even if you owned a chicken, you could calculate the
number of eggs it would bring you followed by the meat on the
chicken itself, subtract costs, and get a good feel for its value.
Same goes for a business, a house, or even other commodities like
oil.
Gold is different because today it doesnt have a practical purpose
in business or in the everyday needs of humans. Yet all of this
does not mean that gold is a chaotic, unpredictable, and naturally
highly volatile asset. Instead, it just means that gold operates by a
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different set of factors and principles and knowing what these are
and what kind of impact they have is key to answering the ever-
present question of are gold prices going up or down?. We look
at some of the major points impacting gold and which economic
data points to follow to know which direction the gold price is
headed.
Inflation
Inflation is regarded as the number one top factor affecting the
price of gold. We said earlier that gold didnt have a practical
business or personal use, but the one use it does have is a
retainer of value and wealth. Therefore it makes sense that in an
inflationary environment, where the value of paper currency is
falling in regards to what other goods and services can be bought
with it, that people should want another form of money (gold) that
DOES retain its value.
THe CPI (Consumer Price Index) is a measure tracking the price
change in a basket of common household goods, and is intended
to give a good feel of how much inflation there is in an economy
and impacting the average urban civilian. The CPI or cost of living
index in most countries is tightly controlled by governments and
might not include key spending areas like food, energy, utilities,
education and health in the attempt to curb concerns about
inflation. The PPI (Purchasing Power Index) is a similar tool but
from a producer perspective. Regardless of whether you look at
the total money supply, benchmarks like CPI/PPI, or just
subconsciously track prices when shopping or paying your bills
gold is very likely to correlate directly in the direction where general
prices are headed and that also means down when there is
deflation.
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Interest Rates
Interest rates are another major indicator of where gold prices are
likely to go. During times of high interest rates, capital is scarce
and in high demand and therefore a large premium is paid
(interest) to those willing to lend out their money. This is a tough
competitive battle for gold to win with its non-profit yielding nature
(unless youre in the gold leasing business, which private investors
are not) and therefore higher interest rates means lower gold price
(negative correlation).
The major economic data point to look out for is the federal funds
rate released by the FOMC (Federal Open Market Committee) 8
times per year in the United States. This essentially sets a target
inter-bank lending rate, which means that it either makes it easier
(cheaper) or harder (more expensive) for banks to borrow money
from each other. Higher interest rates would mean that if a bank
were short on deposits to lend out to people, it wouldnt that easily
be able to just borrow that necessary amount from another bank,
and that would make increase the value of capital and
consequently the rates of return you get from that capital, and as
mentioned earlier, such an environment does not favor gold.
US Economy and the Dollar
One of the major reasons why the US Dollar became the favored
reserve currency around the world (~85% of central bank reserves
are in dollars) is because during a 40 year stretch (1931-1971),
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the dollar was the only form of paper money that was backed by
gold. President Nixon closed this gold-for-dollars window in 1971,
but by then it was too late to do anything about it. Everyone and
everything was already too far invested in gold whether its the
countries who had massive dollar reserves, or oil which was priced
in dollars, and other structural developments that would take much
pain to unravel. Besides the US was the world superpower,
destined for financial stability, so their paper was still as good as
gold to many unsuspecting stakeholders.
So basically the US dollar has taken the place of gold and all its
positive qualities, without there being any form of gold in the
equation. This naturally means that the US dollar became a
substitute for gold, and a cheap one at that if you compare the
limitless paper the US government could conjure up vs the real
limited availability of gold. But the reason gold was valued in the
first place was because of its rarity and lack of counter-party risk,
qualities which paper money does not hold.
So in short, gold will go up and down depending on the apparent
strength of the US economy and consequently the dollar they are
inversely correlated so when the dollar goes up the gold price goes
down. There are several economic indicators to watch out for that
tells us of the strength of the US dollar.
Balance of Payments, Balance of Trade: These items look at
the amount of money coming in and going out of the country. If a
country produces lots of desirable goods, has good investment
prospects and sound economy its trade balance is likely to be in
surplus and its currency will be in high demand as holding it
provides lots of attractive possibilities. The opposite would be a
deficit and a weakening currency. Occasional deficits are
acceptable, especially for a developed country but sustainable
periods of bringing in more value than shipping out of the country
will lead to currency devaluation. This is what the United States has
been dealing with in recent times ($500 billion trade deficit in 2012)
and this not only affects the dollar index against against other
currencies, but affects the relative value of gold as well.
US Debt: The amount of money owed to other countries in the
form of treasury bills can affect the dollar, and consequently the
gold price in a number of ways. There is the impact it will have on
the credibility of the dollar as a reserve currency worth owning
meaning if the US debt gets too big and unmanageable, then
5/17/2014 Factors Affecting The Gold Price
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countries will want to own it less in the risk of never seeing that
money again. The other impact of debt is on inflation, and weve
already talked about how that is a type of environment that favors
gold. For example if all of Americas creditors and purchasers of its
debt decide to cash in that money and decided to buy real goods
and assets in the U.S, there will be an awful amount of dollars
chasing few real physical items, and the prices will shoot up.
Other Macroeconomic Factors: GNP/GDP, unemployment rate,
home sales, retail sales, inventory levels, manufacturing index all
weigh in on the health of the general economy and give signals as
to whether a nation is headed in the right or wrong direction. Good
figures in a multitude of these data points suggest the U.S could be
in the midst of a recovery which would strengthen the dollar while
weakening gold.
World Instability
Any time a major world event happens for example a terrorist
attack, some kind of war, or perhaps some type of crisis this is a
time where the safety of gold ownership is preferred and prices
usually respond upwards. The current financial system of fiat paper
currencies, stock markets, and debt fueled growth can only operate
successfully under the premise that things continue without a hitch.
However when one of the underlying assumptions of this system
starts to break down, it can easily bring down the rest of the system
with it, and at this point gold is the main fallback which transcends
borders and nationalities and is known to preserve value and trust,
even in the most uncertain of times.
Other Investment Alternatives
We mentioned how high interest rates can dissuade investors from
owning gold but other alternatives to interest rates and gold exist to
5/17/2014 Factors Affecting The Gold Price
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make money. Government bonds, commodities, and stock markets
are some of the biggest areas. For example, if the Dow Jones
Industrial Average keeps going up, investors will want to get a
piece of the action and might be tempted to sell their gold to enjoy
some of the gains they keep hearing about on the evening news or
reading in the morning paper. Of course the investment world is not
that simple, but its the general perception and tendencies of the
average investor work that way and perception is more important
than reality. It would be wise to remember at this point that gold is
only valuable as people deem it to be, so temporarily gold prices
could go down if other more attractive alternatives exist (even if
other factors suggest gold is a wise investment and other
investments are in the midst of a bubble). Thats why patience is
often key when being a gold investor. Gold moves in similar lines
with other commodities while is usually inversely correlated with the
US stock market.
Demand for Gold
As our gold demand analysis showed, about 45% of yearly gold
demand comes from jewelry, 45% from investment bullion, while
10% comes from industrial demand. If for any reason one of these
areas showed a great surge in demand, then gold prices could rise
following the natural laws of supply and demand. With China and
India providing much of the fresh demand for gold, the economic
conditions of these countries as well as any regulations, holidays,
taxes that may be present should be closely monitored.
Mining Supply of Gold
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In contrast, supply contractions or new findings can also cause a
change in the price of gold. Recent gold supply trends show that
gold is becoming harder and more expensive to mine, which will
have a upward pressure on the price as population growth and
demand surpasses any new gold supply.
Central Bank Policy, World Currencies
Central banks around the world naturally have a lot of say and
influence on the fate of gold and its use in modern economics. In a
perfect world, where governments and thus central banks act 100%
on behalf of the people and having a sound economic policy, then
the value of gold could severally be marginalized. Yet thats not
how the world has proven to work over the past couple thousand
years. If central banks around the world truly enter a currency war,
as it looks like we are, then inflation will be rampant and
widespread. How much gold central banks decide to keep as
reserves also plays a factor the last several decades had seen
central banks unloading their gold but they have become net
buyers once again over the past several years. All the factors
affecting the US above also affect other economies, and gold will
always serve as a great hedge towards poor economics.
Appreciation in currencies of major gold consumers like the Indian
Rupee and Chinese Yuan will decrease the gold price for them and
increase demand leading to generally higher prices.
Futures Market, Manipulation
We mentioned in another post how gold prices were determined on
the futures market. This form of trading has unfortunately turned
gold into a form of speculative commodity that traders can play
around with to gain short term profits. Claims of manipulation are
rampant, especially with the US government and large banks
having big incentives to keep prices low. Regardless of the
manipulation that might go on here with the questionable short
selling, all the factors mentioned above should win out in the long
term and short term price fluctuations should not be taken too
seriously.
As we said in the beginning, gold can be a tough investment to
value, but the tools are there and the history is there to back it up.

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