Gold is a hedge against inflation. An increase in inflation or inflationary expectations increase investors' interest in buying gold and, therefore, driving up its price; on the other hand, disinflation or a fall in inflationary expectations do the opposite. The price of gold is generally inversely related to the value of the United States dollar because the metal is denominated in dollars. All things being equal, a stronger U, S.
The dollar tends to keep the price of gold lower and more controlled, while a US, S weaker. The dollar is likely to push up the price of gold through increased demand (because you can buy more gold when the dollar is weaker). Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions achieve financial freedom through our website, podcasts, books, newspaper columns, radio shows and premium investment services. Interest rates have a major influence on gold prices due to a factor known as opportunity cost.
Opportunity cost is the idea of giving up an almost guaranteed profit on one investment because of the potential for a greater profit on another. With interest rates holding close to historic lows, bonds and CDs are, in some cases, producing nominal yields that are lower than the national inflation rate. This leads to nominal gains but real money losses. In this case, gold becomes an attractive investment opportunity despite its 0% return because the opportunity cost of interest-based assets that are renounced is low.
The same can be said of rising interest rates, which increase yields on interest-bearing assets and increase opportunity costs. In other words, investors are more likely to give up gold as lending rates rise, as they would be getting a higher guaranteed return. Another driver of gold prices is US economic data. UU.
Economic data, such as employment reports, wage data, manufacturing data and broader-based data, such as GDP growth, influence the Federal Reserve's monetary policy decisions, which in turn may affect gold prices. Although it is not set in stone, a stronger U, S. The economy — low unemployment, employment growth, manufacturing expansion, and GDP growth above 2% — tends to drive gold prices down. Strong economic growth implies that the Fed could make a move to tighten monetary policy, which would have an impact on the opportunity cost dynamics discussed above.
On the other hand, weak employment growth, rising unemployment, weakening manufacturing data and slower GDP growth may create an accommodative Fed scenario for interest rates and rising gold prices. A fourth factor that can affect gold prices is inflation, or the increase in the price of goods and services. While far from being a guarantee, rising or rising inflation levels tend to push gold prices higher, while lower levels of inflation or deflation weigh heavily on gold. Inflation is almost always a sign of economic growth and expansion.
When the economy grows and expands, it is common for the Federal Reserve to expand the money supply. The expansion of the money supply dilutes the value of each existing currency note in circulation, making it more expensive to buy assets that are perceived as a store of value, such as gold. This is why quantitative easing programs that saw the money supply grow rapidly were considered positive for physical gold prices. In recent quarters, inflation has been relatively moderate (just above 1%).
Lack of inflation has been a factor that has forced the Federal Reserve not to raise credit rates, but it has also kept gold prices low, which normally perform better in an environment of rising inflation. This tug-of-war between interest rates and inflation can play a constant tug-of-war on gold prices. Whether gold continues to rise depends on several factors. Central bank decisions on interest rates and inflation affect the price of metal, as lower interest rates and higher inflation make it more expensive.
The same is true of exchange rates, in the sense that a weak US dollar will cause gold to rise. Then there is the supply and demand of the metal itself: gold mining is becoming more difficult over time, which is one of the reasons for the long-term price increase. Gold and greenback prices have an inverse relationship. As the dollar strengthens against other currencies, gold prices will fall as they become more expensive in other currencies, reducing demand.