Determinant Factors for Gold and Precious Metal Prices

For much of human history the most praiseworthy achievements of man were recognized with decorations, trophies and medals made from gold. It is very easy to understand why. The lustrous yellow metal has always been cherished by people from every culture on earth. Gold holds a venerated place in our society as a symbol of wealth and by extension, success. It is quite natural for people to want to mint coins from gold. Prior to the accession of fiat currency, gold was the most sought after material for use as a store of value in commerce. The earliest forms of paper money were actually bank receipts for gold on deposit. Apart from the symbolic and pecuniary worth of it, gold has some limited practical functions. It is useful in dentistry and in the manufacture of mission-critical wiring and electronics. About half of all the gold taken from the world’s mines each year goes into making jewelry. Approximately ten percent of it is used in industry, and most of what remains is accumulated for investment purposes.

Gold is one part of an important asset class that people turn to in times of trouble. The global economic downturn of 2008 triggered a state of being consistent with a massive erosion in the value of stock portfolios the world over. While equity prices swooned, prices for precious metals climbed to all-time highs. During this period the volume of physical gold and silver purchases conjointly saw record highs.

It is fair to say that precious metals are what people buy when they are afraid of paper assets. For some, precious metals represent a safe harbor in which money can be parked while the rest of the world sorts through the consequences of a threatened economic meltdown. For others, precious metals are a savvy bet on the question of how far nations can go with respect to monetizing their economic growth. Folks who aggressively accumulate gold and silver are sensitive to the reality that many central banks have responded to the effects of global recession by printing money. Their thinking is that these central banks can print only so much money before they begin to debase the local currency. When a nation’s currency begins to falter, investors take their money out of sovereign debt and paper assets and they invest it in gold.

Price Discovery Mechanisms for Precious Metals

A current and meaningful price for an ounce of gold, silver, platinum or palladium can be accurately determined by observing the actions of buyers and sellers in an organized trading market. The precious metals futures markets are open 24 hours per day and up-to-the-moment prices for these metals are available electronically to anyone with access to the Internet. In addition, the price of gold is benchmarked twice daily in the United Kingdom in the course of a formal procedure known as the London Gold Fixing. The custom of gold fixing dates back to 1919. Its purpose of it was to establish a daily benchmark for gold and thereby facilitate trade.

Much of the research and energy put into understanding gold pricing has as its focus Western monetary policy and the U.S. dollar. This reflects the size of the U.S. economy as compared to the rest of the world as well the U.S. dollar’s role as a reserve currency.

In the United States, implementation of domestic monetary policy is generally carried out through the Federal Reserve Board (“The Fed”). When the Fed’s monetary policy is gauged by the capital markets to be accommodative, the price of gold tends to rise. This is so because a “loose” monetary policy portends lower interest rates and the potential for expansion in the money supply. Gold bulls favor precious metals during these times because they know that unlike paper, gold supplies are limited by the production capacity of gold mine operators.

A good understanding of the outlook for gold going forward must take into account a likely change in the relative position of the United States as the dominant world economic power. Within ten years the geographical base of economic power is expected to shift toward the rapidly developing nations of Asia. To profit from this shift, precious metals investors will need to quantitatively assess the long-term relationships between precious metals prices, mine production, and forecasts for growth in the region’s pool of investment capital. A larger than expected expansion in this regional pool of money is likely to translate into a rapid escalation in the price of precious metals. Developing countries tend to generate elevated levels of inflation within their economies relative to the developed world. The perceived need for protecting this newly generated wealth against the threat of inflation may further increase the demand for gold and other precious metals in the region.

Factors Determining the Market Price of Gold

As a financial asset, gold is rather tricky to analyze. Gold is substantially different from other financial assets in that it pays no dividends and offers the investor nothing in the way of fixed income. Gold lacks practical demand fundamentals consistent with other commodities. Agricultural commodities such as corn and soybeans can be fed to livestock, which in turn can be used to feed people. Pricing of foodstuffs and other commodities tend to follow a traditional supply and demand curve. Their prices rise and fall in response to seasonal fluctuations in production and commercial demand. Gold prices on the other hand are never so predictable and therefore, are much more volatile.

As stated earlier in this article, gold prices are heavily influenced by U.S. interest rates and the value of the dollar. When U.S. interest rates rise, investors will bid up the dollar because it is needed to purchase these high-yielding instruments. Some of the money flowing into these instruments will come from sales of gold and gold funds, which do not pay interest. When U.S. interest rates decline, enthusiasm for dollar-denominated assets wanes. Some of the money flowing out of these investments will go into the stock market, but some of it will go into gold propelling prices higher.

Other factors that influence the price of gold include mining and production activities. When mining costs (land, energy and labor) go down, gold mining companies can extract it more efficiently from the earth. This can result in a surplus of inventory. Without a corresponding increase in the demand for the metal, increases in mine production will likely drive prices down. The reverse is true when mining costs rise. If the cost of mining for gold goes up there is less incentive for gold miners to expand their operations. This can shrink the world supply of gold and drive prices higher.

Sometimes gold mining activities will result in unexpected price distortions. Mining companies can be very reluctant to close down operations even when their costs exceed market prices. Shutting down a mine is an expensive proposition. The alternative is to keep going and eat the losses for as long as one can bear them. The hope is that market prices will recover and restore the company to profitability. In the meantime, market prices decline rapidly as newly minted gold bars find their way onto the market.

Investment Opportunities for Retail Investors

Today, the average investor has a broad array of investment alternatives to choose from when they want to buy gold. They can purchase physical gold in the form of gold coins or bars. They can buy “paper” gold in the form of ETF’s and gold funds from their broker, and they can trade futures and option contracts on gold or any of the other metals in the asset class. Perhaps the easiest and most efficient way for the retail investor to get involved in gold is through the purchase of gold bullion or gold coins. Gold bars and coins (22 karat or greater) will closely track the price of gold as per the daily London Gold Fixing, and they are sufficiently liquid that they can be bought and converted into cash rather quickly. Some gold coins have numismatic or collectible value as well as bullion value. Their secondary market prices can be a bit more difficult to track and evaluate. A very good source of information about the primary and secondary market value of these coins can be obtained by visiting the monex gold prices website. There, aftermarket pricing is available for a wide range of coins and other products made from gold, silver, platinum and other precious metals.

In 2009, gold prices soared as a result of a weakening U.S. dollar. It rallied further when a persistent Eurozone debt crisis threatened global economic stability. Today, many questions influencing the precious metals markets remain. Where is the US dollar headed, and what is in store for the global economy going forward? Will Federal Reserve policies finally ignite inflation in the U.S. and push interest rates higher? Will geopolitical conflict drive oil and precious metals higher once again? Whatever his opinion, today’s retail investor has many ways of expressing it in a truly meaningful way by taking a position, one way or the other, in the market for gold and precious metals.

Determinant Factors for Gold and Precious Metal Prices
5 (100%) 10 votes