Md. Harun-Or-Rashid
A high gold price might signal the global economy in inferior condition. Investors buy gold as protection from either an economic crisis or inflation whereas they have options to investment in stocks, bonds, or real estate, etc. Notable, the price of gold is moved by a combination of supply, demand, investor’s behaviour, and most importantly, uncertainty. For instance, many investors think of gold as an inflation hedge which has some common sense plausibility as paper money loses value as more is printed, while the supply of gold is relatively constant. Why peoples invest in gold? People do so because they use gold either as a hedge (haven), or a direct investment.
During economic booms, investors opt for riskier stocks with potentially much higher returns, yet in times of market volatility when currencies fluctuate gold appears a safer bet, with steady returns and low risk. Gold has long been referred to as a safe haven for investors during times of market volatility and high inflation.
Gold is benefiting from a flight to safety in global markets, as concerns rise about the Covid-19 pandemic, impact of US-China trade tensions, a host of looming political issues, rising tensions in the Middle East, geopolitical turmoil and the con-current crisis globally. Crises such as wars, pandemics have negative impact on prices of most asset classes; have a positive impact on gold prices since the demand for gold goes up as a safe haven for parking funds.
As such, owning gold really a safe bet? Gold’s reputation as a safe haven investment often makes it the benchmark with which other more volatile stocks are measured. With stocks and shares, currencies and property continuing to falter in an underperforming and wider economy, individuals are looking to diversify their investment portfolios and place their money into physical gold which has consistently outperformed all other forms of investments on the market. But not everyone is so sure. However, unlike a bond, the metal pays no interest. There is no dividend. It may not protect you against the worst forms of inflation. And there is no implicit guarantee that it will appreciate in value.
Also, demand for gold is largely depends on culture, tradition, the desire for beauty and the desire for financial protection. While far from a guarantee, rising or higher levels of inflation tends to push gold prices higher, whereas lower levels of inflation or deflation weigh on gold. Expanding the money supply dilutes the value of each existing monetary note in circulation, making it more expensive to buy assets that are a perceived store of value, such as gold. When inflation rises, the value of currency goes down and therefore people tend to hold money in the form of gold. Therefore, in times when inflation remains high over a longer period, gold becomes a tool to hedge against inflationary conditions. This pushes gold prices higher in the inflationary period.
The movement of currencies varies specifically the US Dollar, since the price of gold is dollar denominated which can be another strong influencer. Gold is not only bought as an investment, but it is also bought for use in other areas such as industry and jewelry making. A falling US Dollar has a tendency to push gold prices higher because other currencies and commodities around the world increase in value when the dollar falls. On the contrary, a strengthening US Dollar often comes about because of a growing US economy. It also pushes down gold prices since gold and the US Dollar has an inverse relationship.
People want to invest or buy gold to protect themselves from volatility and uncertainty. The preference for physical assets makes households view gold as a safe haven, an asset to buy when other assets are losing value. Underlining gold’s attraction as an asset for good times and bad, most investors would buy gold whether the domestic economy were growing or in recession.
Profit/interest rates have a big influence on gold prices because of a factor known as opportunity cost (idea of giving up a near guaranteed gain in one investment for the potential of a greater gain in another i.e. sacrificing next best alternative). With profit/interest rates holding near their historic lows, bonds and CDs are, in some cases, yielding nominal returns that are less than the national inflation rate. This leads to nominal gains but real money losses. In this instance, gold becomes an attractive investment opportunity despite its 0 per cent yield because the opportunity cost of forgoing profit/interest based assets is low. The same can be said of rising profit/interest rates, which boost profit/interest bearing asset yields and push opportunity costs higher. In other words, investors would be more likely forgo gold as lending rates rise since they’d be netting a higher guaranteed return.
Also, the broad factor of uncertainty can influence gold prices significantly. There’s no one specific factor that can be listed here that perfectly encompasses the uncertainty that can move gold, but political uncertainty and/or instability is probably the best example. Put straightforwardly, the stock market covets certainty, and it’s often the enemy of gold prices.
In conclusion, we can’t ignore the effect of human physiology when it comes to investing in gold. The precious metal has always been a go-to investment during times of fear and uncertainty, which tends to go hand in hand with economic recessions and depressions.
(The writer works at Social Islami Bank Limited, (SIBL) as Manager Operations, Certified Finance Specialist, Certified Project Management Analyst.)
