Since the ancient time, people have shown an obsession to gold. Except for an obvious correction in 2008, gold price has appreciated consistently since 1999, reaching its peak in 2011. After being unpegged with the US dollar, gold price is mainly affected by the demand and supply factor. Therefore, it is important to understand the different factors which can affect gold price before we invest in it.
As an investor, Jack wants to diversify his portfolio’s risk, so he decided to include gold in his portfolio in order to hedge market risk and inflation. He frequently hears from the news that Indian festivals and the ETF transactions will affect gold price. So whenever there is related news, Jack will pay more attention and seek for an opportunity to enter the market. However, Jack noticed that his strategy is resulting into loss mainly because there are other factors to be considered when investing in gold.
First of all, Indian festivals actually have minimal effect on gold price. Traditionally, many people think that Indian festivals have a strong demand for gold. But in reality, the demand is really limited and it does not cause much effect on gold price
Furthermore, the global inventory level of gold in ETF is less than 0.5%. Therefore, any fluctuation on the ETF transactions would only lead to a minimal effect on gold price.
In fact, there are five more important factors as listed below:
1) US dollar
Since gold is priced in USD when USD appreciates, gold price will drop correspondingly. Assuming Jack wants to invest in gold. Initially, 100 USD can only buy 100 Oz of gold. Due to expectation of USD appreciation we can buy 120 Oz of gold with the same price tomorrow. As a result, the attractiveness of gold will decline today.
When inflation take place, the corresponding currency will depreciate, metal and commodities will then become relatively more valuable. Traditionally, gold seldom depreciate in terms of real value, so it has been used as a tool to hedge inflation risk
3) War, Natural Disasters
When there are wars or natural disasters, people will sell their asset including local currency and subsequently buy safe-haven assets. With funds flowing to safe-haven assets, gold price will conversely appreciate.
When a country enters recession, people will lose confidence in their local currency. Funds will naturally look for risk-averse assets, therefore bringing gold price up.
5) Domestic interest rate
Take USD for example, when the US government raises interest rate, we can earn interest when we invest in USD. On the other hand, gold as a commodity will not generate any interest. As a result, the attractiveness of gold drops when interest rate rises. Let’s say Jack is deciding to invest in USD or gold, if US dollar provides 1% of interest payment per annum but no interest gain in gold. He will naturally invest in USD.
Therefore, it is important to understand the different factors which can affect gold price before we invest in it.