Let us dive into the topic of Gold and understand the key components that affect the Gold price are. If you have not read my previous article on "A Guide to Gold Investment", I would suggest reading through to understand the available Gold products in the market.
Economics 101, supply and demand are the fundamentals in elaborating the relationship between the buyer and the seller of a resource. So how does it affect the Gold price?
Let's take a look at how both factors affect the Gold price: -
Buyer Perspective: - If buyers demanded more Gold, perhaps due to economic uncertainty and lowered investor confidence (In stocks & other assets), the price of Gold would increase. The appreciation of the Gold price is because buyers are willing to pay more to get their hands on Gold.
Seller Perspective: - Due to the case above whereby buyers are demanding more Gold, suppliers have two options:
Option A: - Ramp up production to meet the increased demand and achieve profits. However, there are two issues with this option, A being that a refinery may not have the capabilities to increase production. On the other hand, another problem is that there is limited supply of Gold globally. Several experts have estimated that there are roughly 190,000 tons of Gold in the world.
Option B: - If a supplier is unable to meet the demand, it will increase prices to the point that it can reap the maximum profit.
However, in many cases where an unexpected increase in demand, there will be a market correction (market equalisation) to a new level. Market forces will drive demand and supply towards equilibrium. The same can happen if we were to reverse the roles whereby demand decreases.
Another contributing factor affecting the Gold price is Monetary policy. For explanation, we will look at the different effects of monetary policies that the Federal Reserve controls. For our readers that do not understand the term "Monetary Policy": -
Definition: Actions taken by a country's central bank to control the money supply and achieve sustainable growth. The two types of policies are "Expansionary" and "Contractionary" monetary policies.
An "expansionary" monetary policy involves manipulating the money supply and/or interest rates to combat recessions or slower economic performance. The "contractionary" policy involves lowering the money supply and increasing interest rates to reduce rapid inflation.
The concept applied here is "Opportunity Cost", coined as forgoing one opportunity that provides the potential for another that offers greater yields. Suppose the Federal Reserve of the United States decides to employ a contractionary monetary policy. In that case, many investors will turn away from Gold to take up opportunities in other assets that benefit from the higher interest rates.
Definition: - "The rise in the price of general goods and services".
Inflation is an indicator that represents expansion in an economy (Economic Growth). The effects of inflation would drive the Gold price upwards, making it more expensive to invest.
Suppose an economy has an excess money supply in the market. In that case, each dollar that you possess is diluted (carries less value). The effect makes it more expensive to buy assets seen as a "store of value".
However, inflation is not necessarily an unwanted effect because it is an indicator of economic growth. Economies that experience inflation will have some intervention by the government in ensuring that the rate of inflation does not go out of control. Central banks will stabilise inflation by controlling the money supply in the economy. Sounds familiar? The previous point on contractionary monetary policy is a technique used to control inflation. Contractionary approaches involve decreasing the money supply and increasing interest rates, enticing people to save more to reduce economic activity.
Currencies have a role in affecting the Gold price. A clear representation of the effects of money on the Gold price is the Gold/US dollar. Gold itself is dominated and denominated in US Dollars.
The short story is that the denomination of Gold in US dollars due to the "Bretton Woods Agreement". The agreement aims to create efficient foreign exchange systems, prevent currency devaluation, and promote international economic growth. The US government realised that most settlements for trade are in US dollars; thus, it pledged to enable redemptions of US dollars for a fixed amount of Gold. However, the system proved to be inefficient, resulting in the abolishment of the practices. The only significant bit of the agreement was that most commodities would be in US Dollars.
Let's take an example where we see a rise in the US dollars against other currencies. What are the effects? For starters, the Gold price in the US will fall. The result is because Gold has become increasingly expensive against other currencies. The market for Gold saw fewer buyers willing to take up higher prices. The effect of a US dollar fall will be an inverse of the stated factors above.
Uncertainty is a concern that affects institutions, business, consumers and investors alike. Current events such as Covid, political unrest and other economic disruptors shape the confidence of the latter. For example, the rampant Covid situation in Malaysia that has seen as many as 5,000 positively affected individuals combined with stricter movement controls negatively affects the economy.
Countries such as Malaysia, a consumer-based economy, rely on their people to generate economic growth. Fear of disease spreading, and slower economic activity has affected the confidence of investors negatively. Investors are more likely to move into Gold because Gold acts as a haven against uncertainty and foreign currency depreciation.
Why is it important to protect yourself against foreign currency depreciation? For starters, the value of a currency against another would be much weaker, and goods from overseas become more expensive.
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[…] Welcome back to our Gold investment series. Today's article is the 3rd instalment of the series to understand how to sell Gold back to your retailer. Viewers that have missed and would like to review previous articles can click the link to read "A Guide to Gold Investment" or "A Short Guide to Gold Fluctuations". […]
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