Published: Tuesday 11th October 2016
Read Time: 3 minutes
Is Gold Worth Its Weight In Gold?
The price of gold fell below $1,300 – reaching a $1243 low on Friday. This is the commodity’s largest drop in three years and a 6% drop over just one week. One of the main indicators for gold is investor confidence in the market.
There is often an inverse relationship between the two. When there is a lack of confidence in the markets, investors look to gold as a haven and this, therefore, pushes up the price of gold – due to the increase in demand – and vice versa.
The Relationship With The Dollar
The key reason why gold collapsed last week was the show of strength from the US economy since gold is hedged against the dollar, resulting in an inverse relation to growth/strength. In the past week, the Fed has given all the right signals about an increase in interest rates coming very soon (this also led to the dollar strengthening against other major currencies). Most investors (60%, to be precise) are certain of a rate rise this December after the US election.
However, there is a possibility of a November rate rise as well if, and only if, the US election polls show one candidate pulling forward significantly – since this reduces the sense of uncertainty within the economy and beyond. But regardless of when the Fed decides to move, the simple conclusion is that the US economy is strengthening, and thus gold prices fell. Just to note, the Fed’s position is not the only indicator – there were other positives in the week – such as the ISM PMI (Purchasing Manager’s Index).
It is also important to look at another influence on the commodity – supply. Gold is currently at one of the highest levels since 1950, with roughly 22.7 grammes for each person on the planet, if equally distributed.
Therefore, using simple economic theory, this increase in supply theoretically leads to prices falling. To add to this, one can also consider the profit-taking within the market a factor for the recent weakness in gold. In other words, gold had once peaked at around $1375 (earlier this year, around July) and the market seemed to be holding and hovering around this price – leaving little room for further advancements.
As a result, the bulls in the market (those that have a long position) have been frustrated with the lack of volatility and consequently sold their positions to cash in on any accumulated profit. As more and more investors close their positions, the supply of gold in the market increases – leading to a fall in price.
In regards to the short-term future, there will also be new entrants to the market, who are incentivised by the more attractive jewellery prices. To add to this, based upon seasonality – the South Asian community is at the peak of its annual festivities – with the traditional Gold purchasing season.