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Tatra banka

28.10.2016 14:03

About gold

What affects the price of gold?

Neither the average extraction volume nor consumption in jewelry production is relevant for the gold.
This is because unlike other commodities only an insignificant volume of gold is actually consumed. Moreover,
a great portion of this consumed amount is recycled, which means that of the actually extracted gold in all history
a great portion is still in circulation. To put it more clearly: the amount of available gold is much higher than the current
production or actual consumption. Given the above it follows that demand for the existing inventory, especially investment,
speculative demand for the store of value medium is the key indicator for gold price development.

Gold as a protection against inflation

For majority of investors gold is the synonym for protection against inflation. Their logic is based on the following facts:

  • Unlike bonds, cash or other dematerialised securities gold represent material goods which, like real property, commodities or works of art, should develop positively with the growing inflation.

  • High inflation (significantly exceeding %) was historically caused mostly by too expansionary policy of central banks (central banks print large quantity of new money and increase the offer), which reduces the purchasing power of cash. Unlike cash, gold represents precious goods, the additional supply of which can only be increased by additional and time consuming extraction. Therefore, gold should maintain its purchasing power, as the increase in its amount is non-elastic. However, the reality reflects the above statements only in part.

Closely connected to dollar

To explain the gold prices developments it is more appropriate to use the USD exchange rate development, or the development of USD trade weighted exchange rate to the most significant business partners.

Reasons for this development:

  • Gold is traded in USD, and as such in case of USD weakening without the change of gold nominal price it is clear that the gold price in USD must strengthen.

  • In other words - if USD devalues to other currencies, it means that for EUR 1 we pay more USD units, consequently the investor will pay more USD for gold.

  • Similar development takes place with other commodities listed in USD, since due to USD weakening the commodity becomes cheaper for, say, a European investor.

  • If USD devalues, it can be generally perceived as the loss of trust in the fundamental reserve currency in the world and the loss of trust in cash as such (as it is happening at present).

  • Gold as an equivalent of cash than overly benefits from USD weakening.

  • Investors think the current interventions of central banks and governments are unsustainable without devaluation of local currencies accompanied by substantial increase in public debt and money in circulation, which, naturally, fuels the attractiveness of the "cash equivalent", i.e. gold.

Gold vs. other commodities during recession

When included in the clients' portfolios, gold can be attributed certain anti-cyclical nature, as it sometimes negatively correlates with other commodities. Silver strongly depends on share cycle. It can benefit from the share market growth much more than gold. Its development is reverse in the periods of corrections. The same holds true for platinum. This dependence is even more severe with industrial metals. The oil vs. gold index is worth mentioning.

The dollar strengthening will always be a risk for gold. This turn with EUR/USD can be brought about by a change in expectations of the timing of interest cycle change in the USA, as the narrowing interest differential would support the dollar strengthening. However, the market does not as yet perceive this risk. A rather long period of stable rates is anticipated in the USA and ECU with the currently low rates. It is not assumed that central bank are interested in increasing the risk of threatening the fragile growth of global GDP by too fast increase of rates. Moreover, low rates are beneficial for the exposed public debt of several countries, since they do not increase the cost of debt management and issue.

Possibly unknown facts about gold

  • There is a good reason for keeping gold as an investment tool - it represents the iron ration for the worst case scenario, e.g. for a possible armed conflict.

  • Adding a reasonable amount of gold to your portfolio may have positive effect on its diversification and productivity.

  • Gold is not a suitable alternative to a passbook where the investor protects their savings before devaluation by inflation, as it represents a volatile speculative tool.

  • The investment fluctuation can be compared to stock markets, but unlike shares it does not earn dividends that could curb the potential drop.

Based on: Raiffeisen RESEARCH