The prices of precious metals are usually based on the current supply and demand. Other factors that can affect these are investor behaviors and current events that impact the world. Everything may sound simple at first, but when you combine all of these, they become counterintuitive.
For example, many individuals consider gold bars and coins to be a hedge against inflation. This has some kind of plausibility because fiat money tends to lose its value the more it’s printed. However, the supply of precious metals is usually constant, and gold mining does not usually add a lot to the current supply of gold in various industries. So, what actually drives the price?
1A Correlation to Inflation
According to economists and professors at Duke University and the National Bureau of Economic Research, it has turned out that gold does not correlate well when it comes to inflation. When the prices rise, this does not automatically mean that you can consider precious metals as your best bet.
If inflation does not drive the costs, then is fear the answer? Usually, when there are sudden market downturns and economic crises, many people tend to flock to precious metals for their investments. This is evident during the time of the Great Recession. However, know that the price of gold was already rising at the beginning of 2008, it was valued near a thousand dollars before falling under the $800-mark. As the stock market plunged further, the prices of the precious metals have bounced back.
With this said, it reached the peak by 2011 at $1895, and in October 2021, it reached $1783. Some of the research like The Golden Dilemma by Harvey and Erb has noted that there’s a positive price elasticity in precious metals. When it goes up, many are lining up with the demand. This can also mean that there are no underlying factors to the price. People flock to gold because it has an intrinsic value regardless of a country’s current monetary policy or the shape of the economy.
This does not mean that the prices are entirely random, though, and it’s not even the result of herd behavior. Many of the forces that tend to affect the price include the wider market, such as the supply chain of coffee or oil.
2Factors to Know
Unlike coffee, these gold bars and coins are not for consumption. Most of the mined gold today is still around except those that are included in steaks and ice creams. If this is the case, one would expect that the prices would go down further because of the abundance of metals. So, why does it not?
One of the reasons is the people who have a constant need for precious metals. Whether it’s for jewelry, various industries, or investments, the demand is rising, and some companies provide them. Fortunately, you can avoid shady companies by reading this article here and checking out how you can start investing in precious metals in the link provided. Some gold necklaces and bracelets end up in a drawer at some point, and they are taken out of the market circulation for a few years.
Countries like China and India consider gold as having an intrinsic store of value. People buying in these countries don’t usually trade them, although occasionally, you may see others paying for appliances using gold bracelets. When the prices are high, the demand will fall in accordance with the demand of the investors.
3About the Central Banks
The big fishes or movers of the prices of precious metals are usually central banks. They are operating in times when foreign exchange reserves are massive, and the economy is cooperating. When the stock market is stable, most major banks will usually want to decrease the number of precious metals it serves. This is because they consider gold a dead asset, and it does not generate returns and revenues, unlike bonds and money from a deposit account.
However, the problem of many central banks is that investors are not interested in gold when the economy is good. This is when they are continually trading at the wrong place and at the wrong time. The result is the price of precious metals falling.
Central banks want to avoid market disruption as much as possible, and this is why they are managing their transactions in a fashion similar to that of a cartel. In the US, the Washington Agreement states that the banks should not sell more than 400 metric tons of precious metals in a single year. This is not a treaty or a law but rather a gentleman’s agreement that many banks honor. This is because unloading too many precious metals will negatively affect their overall portfolio.
Aside from the central banks, another factor that can affect the price is the exchange-traded fund. This is when iShares Gold Trust or SPDR Gold Shares will allow their current investors to buy precious metals without investing in mining stocks. A guide to mining stocks is available here: https://www.investopedia.com/articles/basics/12/beginners-guide-mining-stocks.asp.
Some of these companies are now the major sellers and buyers. Both of them are trading in stocks, and their holdings are measured through ounces of gold. Yet, these are usually designed to reflect the price of the precious metals and not move it in a specific direction.
5Considerations in One’s Portfolios
When you think about portfolios, you need to question yourself about the rationale of why you’re buying gold in the first place. If you’re looking for a diversifier or a hedge against inflation, then precious metals are a reasonable choice. However, it’s still best if you can weigh the pros and cons before investing, so you’ll know where you stand.
At some point, the prices topped at $2,000 per ounce in 1980. Anyone who has bought precious metals since then has been losing money ever since. Investors who purchased precious metals in 2005 would be happy if they sell now. The rules in portfolio management apply to precious metals as well, so it’s best to know these things beforehand.