Buying gold for investment could be risky, if you don’t understand the various factors that drive the price of this precious metal. If you’re planning to invest in gold, then here are the important factors to be aware of as they influence the price.
1) Supply and Demand
Like any other commodity, the supply and demand of gold are the main driving factors behind its price. It’s a basic rule of economics that increased demand for any commodity with low supply boosts its price. On the other hand, strong supply and weak demand push prices lower. The price of gold is also affected by the forces of demand and supply. Since, the production of gold is limited due to physical restrictions in mining, if the consumption of gold increases, it will increase the price.
2) Value of U.S. Dollar
The value of the United States dollar and the price of gold are inversely proportional to each other. A weaker dollar increases the price of gold, while a stronger dollar decreases the price of gold. This is because when the dollar is strong, people are more likely to invest and trade in dollars. When the dollar is weak, people prefer investing in gold by buying bullion coins and gold funds.
Inflation or the rise in the price of goods and services can affect gold prices. During periods of inflation, with the rise in prices, more fiat currency is created, thus decreasing the value of money (dollar) in circulation. Since gold and other commodities are priced internationally in U.S. dollars, its cost automatically increases. Therefore, you have to spend more money to purchase the same amount of gold.
4) Central Bank Reserves
Central banks of various countries hold paper currencies and gold in their reserve. These banks maintain a gold reserve because it strengthens the nation’s currency and acts as a shield against the US dollar due to its inverse relationship. As a result, when the central banks start accumulating more gold in their reserves, the prices of the gold go up whereas the opposite happens when the central banks start dissipating gold and holding more paper currency in their reserves.
Understanding of these factors is important for investors to protect themselves from the effects of gold price fluctuations. Buying gold for investment is undoubtedly a great way of holding an asset that can serve as a hedge when other ways of investment seem risky. Therefore, next time you think of buying physical gold, keep these factors in mind before making the investment.