Economics and Gold – An Inversed Romance

The relationship between gold and the global economy is basically inverted, for those of you who are not too savvy with economics here are some facts that would hopefully give you a better perspective on the subject. Gold prices have been volatile over the last decade with prices stretching from close to 1,900 dollars to 1,100 dollars which indicates that there are elements that affect the prices of the precious metal, but what are they? Surely most would immediately put it down to ‘supply and demand’ that simply holds on to the theory that when demand is high, prices go up and when demand is low, prices drop. Although it is true, what we are looking at here is what drives the demand, what causes people to buy gold for investment purposes or aesthetic purposes. In order to explain this in the simplest way, we have to look at the condition of the global economy when gold prices were high, when gold prices were peaking at about 1,900 dollars ($1,895) in 2011, global inflation was high as economic growth was grinding down to a snail’s pace and stock risks were high. If we examine market activities closely, investors were selling stocks and bonds as economic uncertainty lay siege on investors. Tight regulations on lending by bank halted the growth of companies that were starving for capital and this had a direct impact on revenue generation capacity, which meant that dividend payouts were starting to become ‘unattractive’ and to top it off, the capital markets were drying up which widened deficit gaps. Investors realised that stocks were losing value ‘fast’ and currencies were starting to depreciate and the only safe haven for investors to ensure that they do not lose their wealth due to currency depreciation and rapidly rising inflation was to convert their ‘assets’ into gold and other precious metals such as silver, platinum and palladium. A sudden critical demand for gold was created due to this shift in investment interest from money and commodity based investments into the precious metal market and the results of the shift was the surge in prices of precious metals – particularly gold. In contrast to bleak economic outlooks, when economic conditions look bright and growth projection is positive, investors usually soak up capital markets, stocks and bonds and sell gold in order to finance these attractive investments which inevitably floods the markets with investment gold driving prices down at which point a different demand for gold emerges in the jewellery industry where individuals buy gold for aesthetic purposes which prevent gold prices from falling off a cliff.

Investment vs. Aesthetic

Gold is predominantly bought or sold for two reasons that are investments and aesthetics. Individuals invest in physical gold in order to secure a certain percentage of their wealth, in the event that inflation occurs, they would not lose that percentage of their wealth (as explained earlier, gold prices rise during inflationary bouts), however, gold related investments such as mining stocks, ETFs and other formats of gold are bought by investors on the other hand in order to make quick gains, much like stocks whereby these gold derivatives are bought and sold rapidly for margins. This activity renders gold into a speculative sphere that causes the price of gold to fluctuate and when prices of gold increases, the demand in both investment and aesthetic markets (gold is bought in the form of jewellery) dip and when prices of gold dip instead due to the speculative market, demand for the precious metal increases as people tend to buy more jewellery when gold prices are low. This intricate relationship between gold and economics has been a fundamental aspect of commerce and trade for well over 100 years. Gold is actually deemed as ‘tangible money’ only because it is scarce and governments are not able to produce gold at their whims and fancies each time the treasury dries up as they do with paper currency. Incessant money printing has been acknowledged as the primary reason for paper currencies to depreciate over time. If we look at the purchasing power of a 10 dollar bill in 1950 and the purchasing power of a 10 dollar bill now, the difference is stark, however, when we look at the purchasing power of an ounce of gold in the 1950s and the purchasing power of gold now, the difference would be very little, as a matter of fact the purchasing power of an ounce of gold would have increased. In summary, it can be said that it is not that the price of gold has increased over time; it is actually the value of paper currency that has diminished – meaning you need more money to buy gold now than you would have needed 50 years ago.

Source: http://www.melbournegoldcompany.com.au/

Leave a Reply

Your email address will not be published. Required fields are marked *

*

Please copy the string nbWLHm to the field below: