Why is Gold so Strong?

gold bar

Gold is a highly coveted commodity, but is the causal factor for the strength of the value of gold as simple as it being in high demand? The reason gold is so strong is a combination of factors including its popularity, its stability and its uselessness for anything much more than adornments.

The demand for gold is due to many factors and can be attributed to the fact that the demand for gold is not easily satisfied, giving it value because it is unattainable and rare. Gold is also unique in the fact that even after someone has obtained it, they still want more, with each acquisition being just as valuable. This is known as marginal utility, and this is a trait which gold shares with money – even though you have money you always want more, but you have to work hard to obtain it.

The marginal utility of gold has been high throughout history and most of the 155,000 tonnes which have been mined are still in existence. Despite this, we still mine for gold and extract what we can, making it the most hoarded commodity in the world. Silver was coveted alongside gold for some time, until it was discovered that this metal had industrial uses in photography and electronics for example. Similarly platinum has a price which is much greater than gold, but is not hoarded either, instead being used in industry, primarily in vehicle engines.

However, gold does not have a use which is sufficient enough to encourage us to part with it as an asset. Gold is also easily used as a currency because it is denser than most other metals, is immutable and does not corrode and this allows money exchangers to easily verify the authenticity. Gold is also the most malleable and ductile metal in existence which makes it easily divisible and has historically made gold a preferred metal for coins which cannot be counterfeited.

The Supply of Gold

The rules of supply and demand have proven that when there is an imbalance between supply and demand, prices adjust to correct it. This means that if demand exceeds supply, the price of a commodity will increase to a point where demand reduces due to affordability restrictions, or supply increases to take advantage of the demand.

This balance between supply and demand is always changing and so prices are always adjusting to compensate however, an imbalance has existing in the gold industry for some time because commercial demand is much greater than worldwide production. If this situation were facing any other commodity the prices of that commodity would soar. However, since gold is not consumed – but hoarded – this is not the case. Of the amount of above ground stock of gold, around 120,000 tonnes is available to source at any time. Plus, these stocks are increasing at a relatively rapid rate of around 1.7% each year with the largest annual increase in the last 50 years being 2.1% and the smallest of 1.4% and with advances in technology, the average growth rate of 1.7% per year is expected to continue.

Gold in Demand

Gold is in demand because of its safety as an investment with turbulent financial markets around the world. It is central banks, mutual fund managers, residents from developing countries and refugees of war who have been fleeing a panicked market in pursuit of gold investments. Therefore while gold is essentially useless because you can’t fuel your car with it or take it to the supermarket, this inanimate rock is seen as a safe haven for investments.

At the beginning of the 21st century gold was seen as a relic, and the gold price was just under $300 an ounce. Since then a change has developed in the gold and silver markets where demand is coming from the jewellery market, and from rural and agricultural demand from India, while in the developed world gold was bought as a supplementary asset and often played a complimentary role in jewellery alongside precious stones.

Despite the agricultural sector in India being relatively poor, 70% of the demand for gold came from this area to fulfil the cheaper side of the jewellery market and as financial security for newlyweds. Since food prices were not increasing, there was more income available to buy gold and in this instance the higher prices did not decrease demand.

In western economies gold made the transition from a cheap component of jewellery to an investment as it was turned into small bars and coins. The demand for gold had become a desire for wealth and a way to protect investments from the unstable money systems. Many institutions have also found they inadvertently invested in gold with the introduction of the gold Exchange Traded Funds which sold shares in gold mining companies to those forbidden from physically owning gold. The holdings of these trust funds places them as the fifth largest gold owners including central banks.

For central banks the pressure from politicians and bankers for a paper only currency with no holdings in gold has seen gold sold off, and sidelined as a form of money, which in turn increases the supply of gold. However, in 2007 the finance industry realised that gold was useful in counteracting the swings in the value of the dollar and Germany was the first nation to refrain from other European countries selling their gold. European banks eventually stopped selling entirely while at the same time China and Russia began buying gold assets at a rate to rival the central bank.

Gold is now recognised as a vital asset to have in reserve and higher gold prices have actually lead to higher demand and more buying. Gold prices, and silver, rise in relation to global financial uncertainty and as a result more and more investors are looking to gold, often for the first time. These investors are not seeking out gold to make a profit but to instead preserve the wealth they have in a safe asset.

The Strength of Gold in the Current Market

The value of gold is currently experiencing record highs of 1400.00 and silver is trading at a 30 year high of 27.50 and although the American dollar is strengthening, financial markets are finally taking notice of the situations in Europe. Germany is expecting bonds holders to carry some if not all of the burden from this point and while that is the intention of bond market, investors are distancing themselves from the debt surrounding a lot of Europe.

Where there is no EU baking, investors in Greece, Ireland and Spain feel they are not being adequately compensated for the risk they are taking with these debts and the spread between Irish bonds and the German bonds which are the benchmark is 550bp which is a new record. This now means it is cheaper to insure Iraqi debt than debt for Ireland.

However, the issue is greater than just the un-saleability of Irish bonds because just as the euro dropped four figures, gold surged ahead, being valued at more than EUR1000 which is almost on par with the all time high of EUR1051.40 which was reached at the height of the Greek financial crisis. The President of the World Bank Robert Zoellick has pointed out that gold needs to be once again used as an international reference point for inflation, deflation and future currency values, and that those countries with gold stores can benefit from these strong prices.

The Strength of Gold in the Future

While it is possible to estimate where the above ground stock levels of gold will be in the future in relation to demand from the fashion and jewellery industry, with more gold being held for monetary purposes its future value can be harder to ascertain. Gold investors will determine the value of their stores based on economic, political and personal factors to help them decide when to sell, and others looking to invest in gold for monetary reasons will use the same factors in their decision.

With such a range of variables dictating the price of gold, and factors which can be as fickle as an emotional urge or a political decision the future gold price is also measured against the US dollar, which is constantly changing, making the future value of gold hard to pin down. The value of the US dollar is dictated by changes in quantity and quality, however, it s true value is linked to the financial and political system which can be just as unpredictable.

If the future value of gold were to be considered for investment purposes, investors should be aware of the risks of short term commodities trading. The success of trading in commodities is dependent on knowing and understanding what others will be doing in the short term and a seemingly good investment can sell at a low.

Instead, investors in gold markets should not be doing so in search of a profit, but instead as a way to add security and stability to their investments when currencies are fluctuating and debt levels are uncertain and rising and a gold bar will be as solid in 20 years as it is right now.

Alban

Alban is a personal finance writer at Home Loan Finder, a home loan comparison website.