Too often, you will hear people talk about how the economy affects gold prices and not how gold prices affect the economy. However, whether you are a gold collector, investor, or merely interested in this subject, it is vital to understand why gold prices matter and have a 360-degree image of the precious metals.
Whenever there is a crisis in the economy, the prices of gold always seem to benefit. Currently, the Brexit uncertainties are the primary concern, and studies have shown that the prices of gold might surge to $5000 in 2020. The prices of gold in 2020 are still holding on to strong gains, and recently, the Federal Reserve monetary policy revealed that the Central Bank is maintaining its decision on the monetary policy. They believe that maintaining the current position of the policy will help keep low-interest rates, thus a better economy. This also means that more investors will be in a place to invest in gold.
In this article, we will be focusing on the gold price relationship to the economy to give you clear insight into what happens when the prices abruptly go up or down.
The currency market
One of the areas of the economy that is affected by changes in gold prices is the currency market. Generally, the prices of gold are more of a reflection of the changes in the value of the US dollars and what happens when trading the gold price against the US dollar in comparison to foreign currencies. This means that the stronger the US dollar, the stronger the gold prices. If the value of the currency keeps going up, then the price of gold is bound to rise in foreign countries where the currency is declining in value. The more expensive gold gets, the lower the demand, and this, in return, pushes the price of this metal down. The vice versa is true when the dollar is weak; the price of gold tends to fall. This means that demand for the metal will be high, and this pushes the prices of gold upward.
Inflation and the prices of gold are closely related. Inflation is a threat to the value of financial assets, such as bonds and stock. As such, investors prefer gold as a safer investment over these financial assets, and the situation results in a rise in demand for gold. They no longer trust currencies, and once they turn to gold, the demand forces the prices to go up. In this case, inflation affects the price of gold, and the price of gold impacts inflation, which is a significant aspect of the economy.
Gold prices and interest rates
Just like the other two mentioned factors, the price of gold correlates to the interest rate. This is such that low-interest rates make it easier for investors to choose gold over other fixed-income investments. This is because gold has minimal risk and is high in income, unlike the financial assets that are low in income and posses the high risk of decreasing in value when interest rates rise. High-interest rates, on the other hand, make financial assets such as bonds and stock more attractive to investors than gold. This makes the demand for gold to be low, thus low prices.
From these points, it can be hard to realize how the prices of gold affect the economy, mainly because all the factors correlate. One thing that remains constant is that the way the price of gold behaves in terms of rising and falling is dependent on the situation of the economy. Inflation, interest rates, and the strength of the currency are just some of the main factors that contribute to either a rise or a fall in the price of gold. With this information, you can easily understand how the gold market works, thus making it easier for you to make sound investment decisions.