Gold has been among the few commodities that are always in demand. This yellow metal has always remained in trend, and it’s considered by many the best commodity for investing. In 2011, gold values touched its all-time nominal high of over $1,900 an ounce. After that, however, gold prices have generally been on the downward spiral.
While the prices started 2016 with a steady rally rising for months following the Chinese stock market slump and other major world-wide indexes collapsing the prices started to hit a plateau around $1300 an ounce. Just recently there has been a sell-off in gold and now the price is down around $1230 an ounce. This was the biggest weekly drop in the last two months. Today, we will look at some of the reasons for this decline in gold.
Expected Increase in US Interest Rates
Gold is extremely sensitive to change in interest rates, and the possibility that the Federal Reserve might raise interest rates very soon – according to Fed meeting minutes released recently – largely contributed to the fall in gold prices. You ask how?
The conventional view is that an upsurge in prevailing interest rates tends to cause a drop in gold values. In other words, a rise in interest rates diminishes the appeal of the yellow metal, which does not earn any interest or dividends. Hence, a lower-than-expected frequency would be positive for gold prices. According to Harvard University, this is due to the fact that high interests’ rates imply that interest-paying investments, like Treasury bills, become more attractive.
Consequently, demand tumbles as investors shift their funds into other investments, and hence the value of these commodities, gold included, tends to fall. With this explanation, you now understand why the gold values have tumbled as the Federal Reserve contemplates increasing rates for the first time in many years.
The US dollar has been growing stronger, enhanced by a renascent American economy as well as the prospect for a rise in interest rates in a few months to come. In fact, the US dollar index that tracks the US dollar against foreign currencies has increased by over 20% in the past year.
The US dollar’s value naturally follows an inverse relationship with commodities. In other words, when the US dollar strengthens against other world’s currencies, the prices of commodities, like gold, typically fall. Conversely, when the US dollar weakens, the prices of commodities generally rise. This is primarily due to the fact that most products are freely traded in global markets, and prices are largely quoted in US dollars.
Moreover, foreign buyers will buy commodities with US dollars, and hence, when the value of the dollar tumbles, they will have higher purchasing power, increasing the demand. By the same token, when the value of the US dollar rises, their purchasing power goes down, and commodities become more costly, muting demand and eventually sending commodity prices lower.
With this detailed explanation, you now understand why gold prices decline with the strengthening of the dollar.
Chinese Economic Slowdown
China is the world’s leading consumer of commodities, and the slowdown in her economy has contributed to the steady fall of gold price since 2011.
Since 2009, the Chinese have increased their reserves of gold bullion by 60%. Be that as it may, the People’s Bank of China recently revealed that they had been purchasing far less gold than expected. For the first time in six years, China updated her gold bullion reserves in 2015, implying that whereas reserves had increased, the 57% gain to 1658 tonnes was smaller compared to the 3500 tonnes that analysts were expecting.
Greek Financial Crisis
For centuries, people have turned to the yellow metal to store their wealth in times of economic crisis. However, a piecemeal resolution of the Greek economic crunch seems to have eased worries that the besieged state will leave Europe.
Greek banks reopened recently after a bailout package was agreed, and the cash-starved country awarded a €6.25bn bridging loan. As fears over the flop of the Eurozone subside, investors are finding it more comfortable to hold riskier assets, which earn better returns. Therefore, while government bonds issued by Portugal, Italy, and Spain that pay higher interest rates do well, gold suffers.
For a long time in history, people have used gold as money, since it’s durable, has a high weight-to-value-ratio, and is difficult to counterfeit. Historically, these features made gold valuable as a medium of exchange. Presently, gold retains its worth as a repository of value, despite the fact that it’s no longer used as a type of currency. If you’re an investor seeking to purchase gold as a safe haven or to generate profit, understanding how various factors, as outlined above, affect gold prices is essential to making informed investment decisions.