What Causes Fluctuation in Gold Prices?

February 1, 2019

Multiple factors contribute to fluctuation in gold prices including supply and demand and investor behavior. Gold, which has captivated the world for centuries is often revered as a safe haven for investment and retirement portfolios, most notably in the form of a Gold IRA. Gold is commonly used as an inflation hedge with prices remaining steady or increasing over time.

Gold price fluctuation

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Inflation and Gold Price Fluctuations

Research shows that gold prices don’t correlate well with inflation, so when inflation rises, the price of gold isn’t necessarily going to skyrocket. Yet in times of economic crisis and uncertainty, investors flock to gold.

Gold prices increased when the Great Recession of 2008 gripped the United States. When the U.S. dollar is strong, people are less likely to invest in gold, instead, trading and investing in other things that are more likely to make money. But when the U.S. economy plummets, investors turn to gold, especially in the form of a gold fund, Gold IRAs or Exchange Traded Funds, commonly known as Gold ETFs. These investments are used to buy and hold physical gold or to buy shares in gold-producing companies.

The two main reasons gold prices fluctuate are:

  • Gold typically increases when there is a fair amount of political and/or economic uncertainty. When times are tumultuous, investors look to gold because it is protected from economic collapse.

  • The price of gold tends to decrease when investors are feeling good or secure about the current state of the economy. This is partly due to the fact that gold doesn’t offer regular yields as a typical investment would.

Claude B. Erb of the National Bureau of Economic Research and Campbell Harvey of Duke University explained in the research paper, The Golden Dilemma, how gold has a positive price elasticity. Price elasticity has to do with the economic measure of product quantity demanded or purchased in relation to the product’s price change. Positive price elasticity is an unusual characteristic given demand increases as the price increases.

When the U.S. economy is doing well, the Federal Reserve often expands the supply of currency. A greater supply of money makes each dollar worth less and often affects gold prices, too. Before the current fiat system we have in place today, gold’s value was tied directly to the U.S. dollar. That changed in 1976 when gold moved to a floating exchange. This move made gold prices vulnerable to the dollar’s value. Gold and the U.S. dollar have an opposite relationship, and gold prices are a good indicator of the U.S. economy’s health: when the U.S. economy is thriving, then the price of gold drops. On the other hand, when the price of gold is high, the value of the dollar drops.

Gold Supply and Price Fluctuations

Gold hasn’t really gone anywhere. In fact, almost all of the gold ever mined is still around. This might make some people scratch their heads: shouldn’t the price of gold decrease since there’s so much around?

But that’s not the case. Consumers still want to buy gold, mostly for jewelry and investment purposes. This means that it’s off the market for as long as the consumer owns it, which is usually for years.

Gold mining has been on the decline since the 2000s. This is likely because all the easily accessible gold has already been mined, so now miners have to travel further, dig deeper and work longer to find it. It now costs more money to get less gold, which has halted mining in some countries. Less gold available for mining adds to the price of gold production, which in turn raises the price of gold itself. In fact, the amount of gold stockpiled is 60 times greater than the amount mined each year.

Central Banks and Gold Prices

Central banks hold gold and paper money in reserve. When foreign exchange reserves are large and the economy is healthy, a central bank will want to reduce the amount of gold it has. Why? During times like these, gold is essentially a dead asset to banks as it generates no return.

The issue is this reduction often coincides with when investors aren’t interested in buying gold. This means that the price of gold falls. Because of this, banks try to maintain how much gold they put on the market. Through the Washington Agreement, banks won’t sell more than 400 metric tons in a year to cap gold’s price fluctuations.

How Monetary Policy Influences Gold Prices

Monetary policy has a big influence on the price of gold and is controlled by the federal reserve. This is because of opportunity cost, which is the idea of giving up a near-guaranteed gain in one investment for the potential of a greater gain in another.

Commentary from the Federal Reserve also has the ability to dictate prices. For example, if the Federal Open Market Committee, which meets about every six weeks, suggests rates could rise soon, the price of gold will often decline. But if they imply the rate of gold will remain steady, gold prices will likely rise.

Using Gold Price Fluctuations for Safer Investing

Gold also tends to move opposite of the stock market, so investing in gold can help diversify your portfolio. When the stock market goes down, gold tends to rise in value or remain steady. Having gold in your portfolio is a good way to balance potential losses from other investments. Experts say to keep about five to 10 percent of gold in your portfolio to keep it balanced.