What causes the gold price to fluctuate?
Predicting the gold price is not easy. The trading of gold is carried out in a
global marketplace, and as such is influenced by an enormous variety of
different economic, social, and political factors. This makes it difficult to
relate the fluctuations in the value of gold and silver to one single event
or circumstance. Political, as much as economic, changes can play a huge
role in causing the gold price to fluctuate.
Despite this, there are certain patterns that become evident when we analyse
the fluctuations in the value of precious metals. One of the most prevalent
themes that we can relate to changes in the value of precious metals is one
of the main reasons investors buy precious metals - security.
In the simplest of terms there are a few things that affect the price of gold:
- Supply - The amount of gold mined can be affected. Mining companies shut down, mines reach a point where the amount of gold left is not worth the cost to extract it, or new laws means that operations cannot continue. Conversely, new deposits can be discovered, mining methods refined, or investment increased.
- Demand - Consumer demand grows and wanes for financial or social reasons. Gold also has a lot of uses in technology; new technology can see demand grow. If supply cannot meet demand the price goes up, if supply outstrips demand the price goes down.
- Economic and Political Changes - As discussed below the economy has a big impact on gold's price, and politics affects the economy in sometimes subtle, sometimes obvious ways.
What causes the gold price to increase?
Gold is a well-known asset seen as a symbol of wealth dating back thousands of years. Its history as a valuable asset means that, unlike the vast majority of other financial assets, it is considered to have an intrinsic, tangible value. This means that investors are a lot more confident in the ability of precious metals, such as gold and silver, to protect their wealth.
This is especially true in times of crisis or extreme instability. Political or economic uncertainty can have a hugely adverse impact on investors’ confidence, contributing to poor performance in certain areas of the economy like stocks or the housing market. In such an event, investors look to the one asset that they trust to protect their wealth from economic collapse - gold.
Throughout history there have been plenty of events that have illustrated this. The 2008 financial crisis is the standout example – with gold jumping up to record levels of over £1,150 per troy ounce as investors feared complete global economic meltdown. Although the price fell back a bit over the next few years, recent events provide us with plenty of evidence that threats to our security (financial and otherwise) are often what makes the gold price increase.
2016 has been a very good year for precious metals. Between the start of the year
and the time of writing, the gold price has increased by 40% (£+284/ troy ounce)
while silver has increased by an enormous 60% (£+5.5722/ troy ounce). This has
come during a time characterised by poor economic performance and global political instability, with rising tension across the world, epitomised by the Euro-Middle Eastern refugee crisis and, most recently, Britain’s decision to leave the European Union after
Precious metals tend to thrive in such circumstances and in this latest instance it has certainly proved to be the case. Confidence in the strength of the British economy
outside of the EU fell as soon as Britain’s decision to leave was confirmed. This caused
the value of the pound to plummet, losing 8% against the dollar in a single day. As a
result of this, precious metals priced in GBP soared. This was advanced by the resulting
sense of panic that took over, leading to increased safe-haven demand for gold and silver,
pushing their value up even further.
What causes the gold price to go down?
In the same way that precious metals benefit from crisis or instability, the price of gold or silver tends to drop when investors are feeling more secure. Security nurtures investors’ appetite for risk. When things are going well, investors will feel more confident about the success of more speculative investments, chasing the potential for higher yields instead of running for the shelter of ‘safe-haven assets’. The biggest pitfall of gold and silver in such times is that they don’t offer regular yields. Investors looking to make a regular income from their assets might be more attracted to speculative investments in private companies which, while often prone to failure, also offer the potential for large returns.
Oversupply of paper gold can have an adverse effect on the gold price. Shares in gold ETFs and gold futures allow investors to hedge their wealth through investing in gold, without ever actually taking physical possession of any metal. While this can work for some investors, there is an enormous risk involved as it is highly unlikely that the amount of shares or futures contracts issued can be matched by the equivalent amount of physical gold. The industry works on the assumption that investors won't request physical delivery of their gold, but will be content with the profits made when selling on these gold-backed paper assets. This means that it is possible for more gold to be sold than actually exists. Following the basic economic principle of supply and demand, then, the gold price can be caused to fluctuate by the issuing of gold futures and shares. While large-scale supply has the effect of pushing down the price of physical gold, there are many investors who believe that should the paper gold industry ever collapse, the price of physical bullion would soar.