Gold is probably the most continuously precious metal we use in modern times. The birth of the metal, which occurs due to colliding neutron stars, is an infrequent and dramatic occurrence. As a result, it is a scarce commodity both in the cosmos and on Earth.
The Egyptians discovered gold as early as 3,600 BC due to its inert nature on the skin ever since. Gold soon gained popularity and quickly became one of the world's most sought-after commodities. Perhaps it was the first metal to be used to exchange between civilizations. "We are all star stuff," Carl Sagan once said, "and our jewelry is crashing star material."
The gold price in US dollars is determined by long-term inflation predictions and US interest rates. The exchange rate between a specific currency and the dollar determines the price of gold in other currencies.
1. Inflation Correlation
The National Bureau of Economic Research's Claude B. Erb and Campbell Harvey, a professor at Duke University's Fuqua School of Business, examined the price of gold in connection to various factors. As it turns out, gold has a poor correlation with inflation, and just because inflation increases do not necessarily mean that gold is a good investment.
Therefore, if it is not inflation driving the price, is it fear? Without a doubt, investors flock to gold during times of economic distress. Gold prices, for example, increased during the Great Recession. However, gold was increasing until the beginning of 2008, approaching $1,000 an ounce before plunging below $800 and then rebounding and climbing as the stock market bottomed. Nonetheless, gold prices continued to rise, even as the economy recovered. Gold prices peaked in 2011 at $1,895 and have fluctuated since then. Prices peaked at $1,575.3 in early 2020.
In their study titled The Golden Dilemma, Erb and Harvey emphasize that gold has a good price elasticity. This effectively means that as more individuals purchase gold, the price rises in response to increased demand. This also implies that the price of gold has no underlying "fundamentals." If investors begin to flock to gold, the price will climb regardless of the state of the economy or monetary policy.
2. Monetary and Fiscal Policy
The course of monetary policy and US interest rates (current and expected) are inextricably linked to the dollar's value. While no governing body has complete power over the gold price, the US banking sector has a significant stake in the claim.
The Federal Open Market Committee, or FOMC, meets every six weeks to discuss the future direction of US fiscal policy. The Federal Reserve projected two interest rate hikes by 2023 following their June meeting, precipitating a week-long fall in gold prices, the metal's worst weekly performance in 15 months. Although two years is a lengthy period, whispers that the Federal Reserve wants to raise interest rates sooner than expected signal that the US dollar may increase, possibly weakening gold prices.
The opportunity cost is the glue that links interest rates and gold prices together. Interest rate and dollar value increase the impact on the gold price, but rising inflation, lower interest rates, and a weaker dollar support the gold price. Gold typically benefits from low-interest rates, as low-interest rates reduce the opportunity cost of storing gold. On the other side, gold may come under pressure if interest rates rise, as gold does not pay dividends or interest.
3. Supply Factors
However, unlike oil or coffee, gold is not consumed. Almost all the gold has ever mined is still in existence, and additional gold is mined daily. If this is the case, one will anticipate the price of gold to fall over time, as there is an increasing supply. Therefore, why does it not?
Apart from the fact that the number of people interested in purchasing it is continually increasing, jewelry and investment demand provide some insight. "It ends up in a drawer somewhere," Peter Hug, Kitco's director of worldwide trading, explained. For years, the gold in jewelry has been effectively removed from the market.
While countries such as India and China see gold as a store of value, the people who purchase it there do not trade it regularly (few pay for a washing machine by handing over a gold bracelet). Rather than that, jewelry demand tends to fluctuate in lockstep with the price of gold, and when prices are high, jewelry demand declines compared to investor desire.
4. Central Banks
Hug asserts that central banks are frequently the primary market movers of gold prices. When foreign exchange reserves are substantial, and the economy is performing well, a central bank will wish to cut its gold holdings. Gold is a zero-return asset, in contrast to bonds or even money in a savings account.
The issue for central banks is that this is precisely the period during which other investors are not very interested in gold. Thus, the central bank is always on the wrong side of the trade, even though the bank means to sell gold. As a result, gold's price decreases.
Central banks have attempted to control their gold sales in a cartel-like approach in order to avoid too much market disruption. The Washington Agreement, in essence, specifies that banks will not sell more than 400 metric tons each year. It is not legally enforceable, as it is not a treaty; instead, it is more of a gentleman's agreement—but one that benefits central banks, as selling too much gold at once would have a detrimental effect on their portfolios.
5. Exchange-Traded Funds
Electronic-traded funds, or ETFs, are almost certainly the least influential on gold prices among these seven variables. While ETFs are not intended to be market movers, they are worth noting.
ETFs are basket funds that investors can purchase to gain enhanced liquidity and the chance to diversify their risks over a diverse portfolio of assets at a cheap cost. The SPDR Gold Shares ETF, the largest gold ETF, buys and sells actual bullion in response to investor demand. As investor demand for gold fluctuates, the price of gold may be influenced by the buying and selling activity of exchange-traded funds. Cash inflows into gold ETFs increased significantly in 2016, increasing ETF purchase activity. This purchasing activity is almost certainly benefiting the price of gold.
6. Portfolio Considerations
Regarding portfolios, Hug stated that an essential question for investors is what the motivation is for purchasing gold. It is ineffective as a hedge against inflation. However, when considered a more considerable portfolio component, gold makes sense as a diversifier. It is only necessary to understand what it is capable of and what it is not capable of.
Gold prices peaked in real terms in 1980, when the commodity reached over $2,000 per ounce (in 2014 dollars). Anyone who purchased gold at that time has been losing money ever since. On the other hand, investors who purchased it in 1983 or 2005 would be content with a sale. It is also worth noting that portfolio management's 'rules' apply to gold. The total quantity of gold ounces held by an individual should change in lockstep with the price. If, for example, one wishes to invest 2% of his portfolio in gold, he must sell when the price rises and buy when the price falls.
7. Retaining Value
One advantage of gold is that it does preserve its value. Erb and Harvey compared the pay of Roman soldiers 2,000 years ago to those of modern troops, based on the value of gold in their salaries. Roman soldiers have compensated annually with 2.31 ounces of gold, while centurions received 38.58 ounces.
Assuming a price of $1,600 per ounce, a Roman soldier earned $3,704 per year, whereas a United States Army private earned $17,611. Thus, a private in the United States Army receives around 11 ounces of gold (at current prices). That equates to an annual investment growth rate of around 0.08 percent over 2,000 years.
A centurion earned $61,730 per year, while a captain in the United States Army earned $44,543—27.84 ounces at the $1,600 price or 37.11 ounces at the $1,200 price. A 0.02 percent annual rate of return is virtually zero.
8. Uncertainty
Finally, the broad element of uncertainty has the potential to affect gold prices.
No single element properly encapsulates the uncertainty that might cause gold to move, but political uncertainty and instability are perhaps the most acceptable illustration. The stock market craves certainty and is frequently an adversary of gold prices. Uncertainty over the outcome of Brexit for the United Kingdom and Europe, the identity of the 45th President of the US, and the ability of the Middle East's terrorist threats to be addressed are all issues that might contribute to global growth uncertainty and support rising gold prices.
9. Economic Trends
Prevailing trends have a significant impact on how gold is priced. Numerous variables contribute to the economic picture, and trade, employment, manufacturing, and GDP are critical characteristics to examine when assessing a country's economic situation.
When an economy is steady, gold tends to be less valuable, and this is because demand for other assets that correlate with the economy is more robust. When financial volatility exists, the market gravitates toward safe-haven assets such as gold or cash, which increases their value. While this is not an infallible rule, it is frequently true.
Why Will Gold Prices Increase in 2022?
Numerous investors are concerned about the sharp increase in gold prices. Why is gold increasing in value? Is this acceptable? Should they invest in gold now that it is at such a premium? Or is this a bubble that is about to burst? To assist you in determining the answers to these questions, we have outlined the variables that may have led to the current spike in gold prices.
Since March 2020, most countries have enacted nationwide lockdowns to contain the spread of COVID-19. While this effectively halted the spread of the disease, it also created significant economic upheaval by forcing businesses to close and imports and exports to be canceled.
While the government launched various economic stimulus initiatives to assist citizens during these trying times, interest rates fell, and many investors began to flee riskier assets. This strengthened gold's appeal as a safe-haven asset and is possibly one of the reasons for the gold rate increase.
1. High Liquidity
Additionally, the government announced a slew of economic stimulus initiatives to inject cash into the markets.
Thus, investors had money to invest, but the stock markets were highly volatile, and interest rates fell. As a result, they began to invest in gold, which is believed to be a safe bet at such times. This is also one of the reasons of increase in gold prices.
2. Reduced Gold Mining
The demand and supply relationship is the fundamental factor affecting gold prices. While demand soared, gold mining activities were severely restricted in several countries due to lockdowns. They were reducing gold mining results in decreased supply, which may be one of the reasons why gold prices are climbing.
3. Increase in Gold Prices in the International Market
Gold's price is determined by its international value. The increasing coronavirus cases, mounting US-China tensions, and global economic slowdowns have contributed to a steady climb in gold prices over the past few weeks.
Should Traders Consider Purchasing Gold?
Between 1989 and 2009, investors that incorporated gold in their portfolios with stocks, bonds, and cash performed better. This was true even after investment risk, and transaction costs were factored in.
However, this is not the case when investors add additional commodities like cotton, copper, and live cattle. This emphasizes the different qualities of gold and other commodities. As we have already highlighted, there is arguably no such thing as a commodity asset class, among other commodity investment dangers. Rather than that, gold and crude oil appear to perform differently than the rest.
Bank of America increased its initial 18-month gold price projection from $2,000 to $3,000 per ounce in April, up from $2,000 in July. The institution's analysts predict that prolonged periods of inflation and abrupt economic contractions will combine to boost the gold price and depress the value of the US dollar.
Bank of America believes that financial repression, not gold supply and demand fundamentals, drives prices into uncharted territory. When a government borrows low-interest loans to restructure current debt and finance government expenditures, this is referred to as financial repression. Financial repression, which has been studied extensively since the 1970s, typically results in a corresponding increase in inflation, which increases gold demand.
Other analysts are a tad more pessimistic than Bank of America. These forecasts are consistent with Goldman Sachs' recent increase in its 12-month gold projection to $2,300 per ounce. The multinational investment bank changed its forecasts for the yellow metal in response to concerns about the dollar's long-term viability as a reserve currency and historically low federal interest rates.
Numerous pundits and gold bugs, such as E.B. Tucker of Metalla Royalty and Streaming, have a long track record of correctly forecasting gold price fluctuations and are positive on the yellow metal for 2022. Tucker told Kitco News that as the US currency continues to fall, he expects gold prices to stabilize at around $2,500.
All investing involves risk, and precious metals investing is no exception. The solution, of course, is to diversify risk across asset classes. Nonetheless, like any other asset, gold investing carries opportunity costs and market risks and is susceptible to speculative bubbles, similar to equities.
One disadvantage of gold investing is that it does not generate dividends and requires annual recurring capital contributions. This is why gold is frequently referred to be a "zero-return" asset. There is an opportunity cost to investing in gold, as you might instead invest in dividend-paying equities that consistently reward you handsomely.
Although economists are bullish on gold at the moment, investor opinion can shift swiftly. The price of gold and silver might overnight sway the asset's value in the opposite direction. Investors should commit a tiny percentage of their portfolio to gold and other precious metals to be on the safe side. For many, a 5% allocation is sufficient to protect against market declines. Additionally, they should invest through an IRS-approved third-party custodian to ensure that their bullion is qualified for inclusion in an IRA or 401(k) plan (bullion held at home cannot be included in tax-advantaged retirement savings accounts).
Summary
To claim that economic uncertainty is the most significant leg to stand on when preparing for the future appears counterintuitive. If the epidemic taught us anything, it is to prepare for the possibility of being unprepared. Uncertainties continue to surround fresh COVID outbreaks generated by changing strains and adamant detractors. Investing in gold is more appealing than ever because it serves as a safeguard for your wealth.
The good news is that COVID-19 created a lull in the market that is waiting to be filled by enthusiastic investors. Given the present rapid changes in the global environment, along with more figurative changes in the geopolitical and economic climates, now is the best time to invest in gold and a company that speaks the language of gold.
If you are concerned about gold prices, it is probably a good idea to consider the health of specific countries' economies. As economic conditions deteriorate, the price (typically) increases. Gold is an uncorrelated commodity. It can serve as an excellent diversifier for a portfolio in small amounts.
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