Gold – What affects its price?

Oct 23, 2013 No Comments by

 

Gold prices have spiked up from $800 an ounce in 2009 to $1900 in late 2011. Let’s have a look at the major factors which have led to the correction of about 30% in the gold prices from its peak.

  • Gold prices are considered one of the safest investment options. Though returns are less but the risk is also less. It shields the investors from all economic, financial and geo political risk. So, whenever there is crisis investors draw out their money from government bonds and financial markets and put it in gold. This is what happened in 2008. After the sub prime crisis everyone fled to gold which lead to rally in gold.
  • Historically, Gold performs when there is a high risk of inflation. Investors consider gold as a hedge against inflation. Central banks all over the world are infusing huge amount of cash in the system in the form of loose monetary policy and QE. Inspite of this, barring India if we see the inflation rate all over the world its not imposing any risk. In September 2013 US inflation rate was 1.5%, Europe was 1.15% and China was 3.1%. So, low inflation has led to poor performance of gold.
  •  Gold provides returns only on capital appreciation. If we look at other asset classes they provide alternate source like real estate provide you with rent, stocks with dividends, bonds with coupons etc. So, since the economy is seeing a recovery investors are fleeing more to these risky assets.
  • One argument is that the countries with huge sovereign debt will have huge risk on their government bonds. So, investors will abandon these and move to other assets. But all these countries have huge reserves of gold. At any point of time they can dump this reserve to cut down on their debt. A report that Cyprus might sell a fraction of its reserves (about $520 million worth of gold), triggered a 13% fall in gold prices in April.

 

As of now, the financial crisis of 2008 is over. The global economy has recovered from its lows and is now on a growth trajectory. If we see the returns on gold are very less as compared to stocks, real estate or even bonds. Gold is used to hedge against risks and inflation. It will be appropriate for investors to have a portion of their portfolio in gold to face the worst case scenario. But seeing the larger picture other asset classes look more attractive.

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