Before considering an investment in gold, it is helpful to become knowledgeable about some of the more prominent factors that can influence the price of gold. As with virtually any asset, there are multiple factors that can exert an influence on the price of gold at any given point in time. As a result, there is no one single factor that you can follow that will divine with certainty which way gold is headed next. Still, by monitoring a variety of influencing factors, you can better make decisions regarding the timing of your gold investments.
Because gold is a physical commodity as well as a form of money, there are some factors that can influence the price of gold directly, while other factors may influence the price of gold inversely. This will make more sense after the following discussion.
- Supply and Demand
Virtually every physical commodity in the world is affected by changes and trends in the supply and demand for that particular commodity. Simple economics teaches us that if there is a surge in demand—and/or a sharp decline in supply—for a given product, then the price of that product will typically rise in price and vice versa.
The supply of gold will fluctuate based on the overall level of gold mining production and also from the amount of gold that is recycled from old jewelry and other sources.
On the demand side of the equation, gold has been a valuable and highly sought-after precious metal for coinage, jewelry, and other uses since the beginning of recorded history. Though the largest demand for gold comes from those who use the metal to create jewelry, gold is also used to manage risk in financial portfolios and to protect the wealth of nations as central banks of various countries may at times acquire gold to support the value of their currency.
These diverse uses for gold mean that different sectors in the gold market may rise in prominence at different points in the global economic cycle. This self-balancing nature of the gold market means that, typically, there is a sustained base level of demand. - Inflation
As we mentioned earlier, price inflation—when it occurs—is a powerful reason to consider an investment in gold. During times of inflation, physical, tangible assets tend to rise in price. As gold bullion is often referred to as the “ultimate store of value”, there can be a strong surge of demand for gold during periods of inflation. This phenomenon occurred most notably in the late 1970’s. As the overall rate of inflation rose into double digits, the price of gold bullion soared over 700%.3
Conversely, if inflation peaks and begins to decline sharply, a great deal of gold selling may occur as many investors unwind the positions they bought originally as a hedge against inflation. This aggressive selling and increased supply can serve to drive the price of gold bullion lower. - Geopolitics
Any number of unexpected world events can lead to shocks in world economics. Coups, wars, debt crises, political tensions, economic hardships, and so on can all lead to heightened tensions in the political and financial markets. The price of gold is typically, but not reliably, positively correlated with rising geopolitical tensions. Quite often, the reaction in the price of gold to unexpected events is swift and pronounced. It should also be noted that waiting for an unforeseen event to occur and then buying gold often involves getting in “too late”, i.e., after the gold market has reacted to the news. As a result, and as future shocks are inevitable, some investors may feel compelled to hold a portion of their portfolio in gold on a long-term basis as a hedge against any variety of unforeseen events.