Gold is perhaps one of the most popular of the precious metals. Whether you are a speculator, an investor in Gold bullion or simply one likely to purchase Gold jewellery, man's fascination with gold has only grown over the years.
As a trader, you might have been baffled by the price volatility in Gold. It is also very likely that your attention might have been drawn towards Gold, largely thanks to mainstream media which tends to be especially fond of Gold during major monetary policy changes. So, why is there so much fuss about Gold and what really influences the prices of Gold?
If you are trading Gold, or want to trade Gold, then you should know what affects the price of Gold:
1. Supply & Demand
Let's start with the classic answer, Supply and demand; which forms the basis for any commodity that is being traded. Supply in Gold usually comes from Gold mines spread across the world. South Africa comes in at the 5th position in terms of Gold mine production, among other countries such as Mexico and Ghana, to name a few. Gold deposits are limited in nature, so there is only a finite amount of Gold (including bullion bars, jewellery, coins etc). It is also relatively expensive to extract Gold, although once extracted, gold retains its value regardless of the number of times it is recast into different shapes or whether it was used for industrial or private consumption purposes.
Gold prices can rise and fall based on both supply and demand.
When supply falls, which is nothing but slower than the usual pace of Gold extraction, prices can rise. At the same time, when there is unprecedented demand for Gold, prices can quickly shoot up.
2. Inflation & Monetary Policy
Gold is often said to be a hedge against inflation and has stood the test of time. When inflation rises (which results in depreciation of the paper currency), investors tend to purchase Gold which offers better returns than the paper money investment such as stocks or bonds. Gold also tends to be volatile when Central banks try to influence a currency’s value by engaging in Quantitative Easing.
The chart below shows the Gold/Euro (XAU/EUR) daily chart during late 2014 and up to mid-2015. Notice how Gold prices rose sharply in relation to the Euro? The rise in Gold was fuelled by the fact that the ECB, the European Central bank was preparing to print more money (thus depreciating the value of the Euro currency). Gold was therefore the investor’s obvious choice.
3. Safe Haven Asset
Gold is considered to be a ‘safe haven asset.’ In other words, when there is a crisis in the financial markets or a rise in geo-political tensions, investors immediately flock to buy up Gold. This is due to the fact that Gold never loses its value compared to paper currency. Therefore, Gold prices often tend to shoot up during serious global economic or political crisis. The chart below shows how Gold prices (USD) were trading during the prolonged Ukraine crisis with Russia.
4. Speculative/Paper Trading
Whether you like it or not and whether you agree or disagree, Gold remains one of the most heavily manipulated commodity markets. The reason behind this is because trading Gold is a lot easier than actually ‘buying’ Gold. Gold futures are traded in the Chicago Mercantile Exchange, known as COMEX. The COMEX Gold offers futures contracts, where traders can buy (or sell) Gold for a future delivery. However, when the time for delivery comes closer, traders simply roll the futures contract over into the next month and thus avoid taking delivery of Gold. This is a common practice when it comes to trading Gold futures. Another aspect of ‘Paper Trading’ Gold is the ETF’s or Exchange Traded Funds. Here, a trader can simply buy as many contracts or shares as they want to in the ETF, and with the same ease, traders can offload their positions as well.
The chart below shows some of well known instances, known as ‘the fat finger’ incidents where Gold prices fell without any fundamental reason, leading many to believe that the sharp and sudden price volatility in Gold prices was a result of a large hedge fund or a Central Bank unwinding their positions in Gold.
Gold Futures drop sharply by 5% in a mere 15 minutes.
So does this mean you should leave Gold alone?
Not at all. By having a basic understanding of the factors that influence Gold, you'll be better equipped to manage your trades and risk.
What factors do you look at before you trade Gold?