What are the reasons that the gold rate goes up and down? First, personal and industrial demand; second influences by central banks and major mining companies; third speculators and traders; and lastly war and national emergencies.
1. Personal and Industrial Demand
The biggest factor influencing the gold rate is demand for jewellery, which consumes two thirds of the annual gold production. Here, India contributes 27% to the demand. India has a long history of an affinity to jewellery of this precious metal. China is lifting its restrictions to possess gold. This additionally drives up demand for gold.
Industrial demand accounts for around 12% of gold demand. This includes uses in medicine. Gold is a favourite material in the industry as it has a high thermal conductivity and high resistance to corrosion. Demand for jewellery and industrial increases over the years as the population grows. A further boost to gold demand comes from the emerging markets (India, China, Middle East etc.) which become more industrial and its citizens wealthier.
2. Central Banks
Market participants with large gold reserves, such as central banks and mining companies can influence the gold price significantly. To reduce the level of the gold price, gold is sold (to provoke short sales). To increase the price, gold is either sold or production is stepped up.
However, central banks hold less gold reserves than is usually believed. In 2010 only 16% of the produced gold was in possession of central banks. Further, the Washington Agreement on Gold (WAG) from 1999 puts a cap on the sales of gold by its members (United States, Japan, Europe, Australia, Bank of International Settlements and the International Monetary Fund). This agreement limits the sale to less than 500 tonnes annually.
Besides influencing the gold rate by means of selling and buying, central banks also have a power over the rate by changing interest rates. High interest rates makes an investment in gold less favourable, as this precious material produces not interests.
3. Speculation and Trading
Of course, gold is not only in demand for further processing (industry) or just showing off (jewellery), but also for speculative motives. This is same as other commodities, such as oil, wheat and copper. Gold can be used to hedge against inflation and the devaluation of currencies. Inflation reduces the value of currencies. Thus, gold in a portfolio eases the loss. Also, the price is negatively correlated to the US dollar value. Meaning, if the dollar weakens, the gold price will rise. More speculative actions are futures and options where investors can even benefit from falling prices of this precious material.
4. War and National Emergencies
The last factor influencing the gold rate is national emergencies and crooks in the government. On the one hand, war times reduce gold purchases, as people have less disposable income, and probably other priorities (for example to survive). On the other hand, in such extreme situations gold might bring a stable value into the portfolio, as the national currency is likely to suffer. Think about the hyperinflation in the 1920s in Europe, or Zimbabwe’s current situation. Another issue are dictators who nationalize gold mines, restrict export or just steal the supplies from the central bank.