Factors that Affect Gold Prices

There are many factors that affect gold prices, but sentiment, hedging, currency movement, and speculation are probably among the strongest.

Uncertainty

John Maynard Keynes called the gold standard, the idea of pegging currencies to gold, a barbarous relic. He felt that a central bank must be able to manipulate the money supply easily, increasing and decreasing it to match the bank’s view of conditions in the economy and the world.

If the amount of money in the economy must be directly proportional to a quantity and price of gold though, it is much harder for regulators to, in effect, make a country’s money more or less valuable to meet current needs.

Many people think that would be a good thing, believing that the markets know what they are doing, and regulators do not. With a gold standard, then, there is, or appears to be, stability. The amount of money in the system, its value and its price, are not so easily altered.

This notion of constancy in a world of change attracts investors in times of instability, which is why uncertainty is one of the primary factors that affect gold prices. Buying gold feels like buying a real asset, something with a value that is unquestioned and unchanging. In reality, of course, any gold chart shows tremendous price swings, often uncorrelated to real-world crises. However, it is this lack of correlation that some investors seek.

Hedging

In its most general sense, hedging is laying off your bets. In financial terms, hedging is a way to decrease financial risk by balancing positions so that a gain in one will offset a loss in another.

To use a very loose example, a hedger might buy an airline stock and an energy stock, because airline stocks tend to go down when fuel costs rise, and the reverse. Historically, precious metals have sometimes moved in a different direction than stocks. Therefore, gold has been used as a hedge.

As it happens, gold and stocks are moving in the same direction in October 2010, though gold is moving farther and faster. Right now, gold is not working as a hedge against stocks. However, it is moving against the dollar, and the dollar is going down.

Currencies

Sometimes, governments want their currency to be less valuable. It makes the stuff a country exports cheaper for foreign buyers, so they (theoretically) buy more of it. It makes the stuff citizens buy from foreigners more expensive so they, (theoretically) buy less of it. Low money is good for a country’s balance sheet, in some ways.

A central bank might not even want its currency to fall, but might be forced (by the logic of its financial views) to take actions, such as lowering interest rates, that cause its currency to crumble. If a country seems unstable or its leaders unwise, that might make its currency fall as well.

However, if United States money is getting less valuable, and Gaean money, say, is getting more valuable, an investor might feel like selling the dollar and buying the Gaea.

An investor who is not certain what the distant Gaeans might do, though, could buy gold instead, because the price of gold, uniform around the world, will go up in dollars as the dollar falls. Right now, a falling currency is one of the strongest factors that affect gold prices.

In a currency war, gold might go up everywhere, as falling currencies create inflation.

Inflation

Brilliant people disagree about the causes and effects of inflation but agree that inflation is one of the factors that affect gold prices. Inflation certainly rewards debtors and punishes savers, eroding the rewards of thrift. (A small amount of inflation is built into our financial system though, to keep things going.) In general, inflation makes money less valuable, making non-monetary assets like gold more valuable.

Politics

Coups, wars, upheavals, and unpleasantness are all believed to have a strong effect on the price of gold. On the other hand, some investors believe that the peak of the unpleasantness is the precise time to sell, exactly when new investors think the party’s beginning. Speculators have to be careful to stay with the crowd, but in its vanguard.

Speculation

Speculation is one of the major factors that affect gold prices. Speculators cause the price of gold to go up by believing that the price of gold will go up.

Speculation is not investment. It promises great returns, but is founded on impulse or hunch rather than reason. Speculation has no doubt paid off for some, and, as certainly, it has impoverished others. When the price of an item goes parabolic, like tulips in a long-ago Dutch craze or bowling alleys in the fifties, it’s not a sign of a new price plateau. It’s a sign that the end is near.