MYSTERY BEHIND GOLD PRICES

By: Akshay Bansal

History 

Gold has been widely used throughout the world as a vehicle for monetary exchange, either by issuance and recognition of gold coins or other bare metal quantities, or through gold-convertible paper instruments by establishing gold standards in which the total value of issued money is represented in a store of gold reserves. However, production has not grown in relation to the world's economies. Today, gold mining output is declining. With the sharp growth of economies in the 20th century, and increasing foreign exchange, the world's gold reserves and their trading market have become a small fraction of all markets and fixed exchange rates of currencies to gold were no longer sustained.

Pricing of Gold and Determining Factors 

Today, like most commodities, the price of gold is driven by supply and demand as well as speculation. However unlike most other commodities, saving and disposal plays a larger role in affecting its price than its consumption. Most of the gold ever mined still exists in accessible form, such as bullion and mass-produced jewellery, with little value over its fine weight — and is thus potentially able to come back onto the gold market for the right price. The actual price of gold is determined by how much gold the World Gold Council is willing to sell. As with any market, the price is a factor of supply and demand.

Most people look at the price per troy ounce of gold in the same way they consider the stock market. As investment vehicles, both move up and down, and it’s often difficult to determine what causes the fluctuations. In reality, the price of gold is closely connected to a few core factors. These factors appear simple on the surface, but are part of a complex system that can be confusing to novices.

In this article, we’ll briefly describe some of the things that influence the movements of the price of gold. We’ll take a look at currency inflation, the role of central banks, and other dynamics that cause an increase in demand. This is not meant to be a comprehensive tutorial. Rather, it will provide a basic framework for understanding how gold prices move.

Currency Inflation

Inflation is often thought of as an increase in the prices of good. For example, when consumers visit the grocery store and notice the price of fruit has increased, they attribute the increase to inflation. This perspective is inaccurate. Inflation is technically an increase in the money supply. This has a direct effect on how gold prices move in relation to a country’s currency.

To explain, suppose you used every U.S. dollar to purchase every product in the world. Further suppose the money supply is then doubled. The extra dollars now floating through the system represent inflation. The value of every existing dollar declines by half. Essentially, it would now require two dollars to purchase something that was once sold for a single dollar.

Gold is used as an exchange unit of value because it cannot be arbitrarily produced. It is a near-perfect store of value against supply and demand. When the supply of dollars (or any currency) is inflated, the price of gold increases as the per-unit value of the currency declines. Conversely, during times of monetary contraction (i.e. when dollars are “soaked up”), the price of gold goes down.

Central Banks

The above discussion leads directly into the role of central banks in the context of how they influence gold prices. They can do so in two distinct ways. First, central banks can decide to sell a portion of their reserves or buy more on the market. The amount sold each year is limited to 400 tonnes to help avoid a glut in the market that drives prices downward.

The second way central banks influence the price of gold is through loan agreements with the central banks of other nations. This area is incredibly complex and involves the International Monetary Fund.

Both levers (i.e. purchase or sale on the market and loan agreements) have a powerful influence on interest rates and thus, the sale of government bonds. For this reason, central banks usually try to keep the price of gold from climbing.

Other Factors

Several other factors can trigger a surge of demand for gold, which pushes its price upward. For example, during times of political unrest and war, countries often travel a path of monetary expansion. This causes the nation’s citizens to lose faith in the value of their currency. As a result, they move their assets into gold.

Mining production can also play a role. While gold cannot be arbitrarily produced, it is mined each year throughout the world. Typically, only a small amount is mined, which means the world’s “above surface” supply remains relatively static.

Large deficits also support high gold prices. When deficits become extremely high, there is a risk of default. This drives people from the nation’s currency into gold, triggering another surge in demand (and price).

Tracking and predicting fluctuations in the price of gold is difficult because there are so many factors at work. If you’re thinking about selling your gold jewellery (e.g. watches, necklaces, earrings, etc.) to take advantage of the current high prices, now may be an ideal time. We may look back in a year and wonder if we’ll ever see the current peaks again.

Indian Market and Gold Prices

The gold rate in today's market depends entirely on the demand and availability of the metal. So unpredictable is the gold rate that not even those in the business are able to forecast what the price might be in the near future, stating that trying to graph the gold rate over a period of time would be inaccurate as well as ineffective. But those in the commodities market seem to have a batter grasp on the gold rate because gold is a commodity and gold rate analysis is possible when using only that commodity for calculation. And they state that even though the analysis is so complex, it will provide an unambiguous picture of the gold rate in the future.

We find that in Indian market, there is more fluctuation in the gold rate than in other markets. Indian buyers are more emotional in their investments because their traditions play a large role. Also, in Hinduism, God's word carries a lot of weight. Gold is pure as well as auspicious, meaning that it bodes well for the future, promising success and good fortune and is something which should never be sold unless one is focused to do so by circumstance. Indian buyers consider their traditions before investing - and then go ahead if all seems well.