Following the coronavirus pandemic, the global economy is yet to stabilize. In fact, the price of gold has been skyrocketing, and investors are seeking new ways to diversify their portfolios. Since gold serves as a hedge against inflation, its demand has risen.
In 2021, the jewelry industry had the highest demand for gold (55.4%), amounting to an estimate of 2,229 metric tons. This was followed by the investment industry (25.02%). You can visit https://www.statista.com/ to view the complete report.
Today, gold is not only used for making jewelry and investment purposes but also for the production of medical equipment. The demand for the commodity is now higher than at any other time in history. This article explores how an increase in demand for gold coins and bullion is affecting the economy.
Factors Affecting the Price of Gold
The key factors that drive the price of gold are:
- The Central Bank reserve
- The current value of the USD
- Global industry demand
- The need to protect wealth
- The level of demand from investors
- Global production rate
Let’s discuss these factors in detail.
The Central Bank Reserve
Central Banks do not only hold paper currencies. Their reserves are now diversified to include precious metals of high value. The more their reserves consist of gold, the more the commodity’s price rises.
The Current Value of the USD
When the USD is strong, it weakens the price of gold. But a weak USD gives people the opportunity to buy more of this yellow metal, thereby, increasing its demand as well as its price. Therefore, during inflation, the price of this commodity rises. This inverse relationship is the reason investors use this commodity as a hedge against inflation.
Global Industry Demand
The largest consumers of gold come from the jewelry industry, and the largest users are India, U.S., and China. Other industries that utilize it are investment, Central Banks, and technology. As mentioned earlier, gold is now used to create medical devices and electronics such as GPS devices; as the demand for these items rises, the price of the raw material also rises.
Demand for Investment
Following closely on the heels of the jewelry industry, investment is another industry that has a high demand for this yellow metal. Some investors prefer to hold the physical metal while others invest in ETFs (exchange-traded funds) and shares of mining companies. Irrespective of the investment method used, it still affects the price of the metal. You should consider reading the Cayman Financial Review before investing in precious metals.
The Need to Protect Wealth
Gold has a long-lasting value. It is considered a haven during periods of economic uncertainties, devaluation, inflation, and political instability. Its value increases when the value of paper assets, such as stocks, bonds, and mutual funds, falls. This can increase its price.
Global Production Rate
The largest producers of gold in the world are China, Australia, Russia, the United States, Canada, Ghana, Mexico, South Africa, Uzbekistan, Indonesia, Peru, and Sudan. A total of 3,561 metric tons was produced globally in 2021, 3 percent lower than in 2018. Some experts believe that miners have reached the peak, leading to a decline in annual production.
Miners may have to look deeper or find means of exploring difficult-to-reach reserves. With recent innovations such as data mining using artificial intelligence, the process may become easy and somewhat economical. But the process of smart mining may add up to the cost of the precious metal.
How Does Gold Price Affect National Currencies?
The United States stopped using the gold standard in 1971. However, the yellow metal has a major influence on the value of the US Dollar and other currencies. Here’s how it affects national currencies:
National Imports & Exports
A country’s currency is dependent on its volume of imports and exports. If it exports more than it imports, the currency will appreciate in value. Otherwise, the country will experience devaluation.
Therefore, a country that has more gold in its reserve will have a strong currency when the price of the metal increases. This is because a little portion of its export will have so much value.
On the other hand, a country that imports more gold will have a weak currency when the price of the commodity increases. Countries that are worst-hit are those that produce gold-backed items but do not have any reserves, including those whose central banks buy the yellow metal.
When a central bank makes such a purchase, it affects the volume of currency in circulation. There will be an excess supply of money in the country, which can lead to inflation. This is because more money is required to purchase precious metals.
The Fear of Inflation or Devaluation
Without a doubt, an inverse relationship exists between fiat currencies, such as the USD, and the price of the yellow metal. However, this does not mean that the metal is a measure of the currency’s value. The relationship is not always inverse.
Among the factors that drive the price of gold, the value of the US Dollar is just one out of many. Therefore, if there is a rise in industry demand for the metal, it has nothing to do with the country’s currency. At that time, the price of the metal will rise, but the currency might be faring better too.
Because investors are afraid there might be inflation or devaluation, they rush to purchase precious metals. This shows that many people have lost faith in their local currencies. Hence, economists and policymakers need to determine whether there is really an inverse relationship between both elements.
The Bottom Line
Although the gold standard (read more here) is no longer in use, the commodity still plays a major role in the global economy. It is used as a hedge during inflation or as an alternative to paper assets. The value of gold is enduring. Therefore, it will continuously influence foreign exchange.
We discussed the factors that influence the price of the metal. They include central bank reserves, the value of the US Dollar, the global annual production, and the demand from investors. These factors should be properly analyzed as a combination of two or more factors can affect the health of a country’s economy.
