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The Law of Supply and Demand and How it Affects Gold
The law of supply and demand
There are a lot of factors that influence the price of gold and the fundamental and psychological factors that many people overlook. While these factors might seem inconsequential, they’re often underrated. If you’re considering the many factors that influence the price of gold, search no further than supply and demand. Monetary policy and regulations also play a part, as well as economic forecasts and historical data. However, knowing supply and demand principles will take you a long way when you’re looking to diversify your portfolio by investing in gold. Whether buying physical bullion coins or investing in gold mining stocks, it’s essential to keep it simple and focus on the “laws” of investing — diversification.
As with any good or service, increased demand with constrained or low supply tends to pull higher prices of that good or service. Likewise, a surplus of a good or service with stationary or weak demand can push prices lower. It doesn’t take a financial analyst or economist to know that demand for that asset will rise when a commodity is in a period of low supply. The result is that prices go up, and the same happens with gold.
Due to it being both a consumer good, such as jewelry or technology, and an investment asset, gold retains its value throughout time and increases in value during times of financial uncertainty. Additionally, it acts as a versatile hedge against inflation — more than cryptocurrencies and similar recreational investments. Financial institutions and pension funds own massive supplies of gold which they leverage when necessary to hedge against losses. That’s why governments value gold as the world’s most valuable asset. Gold is consistently in demand, is in short supply (scarce), holds its value, and can be a transfer of wealth for future generations.
Another factor that impacts supply and demand is the value of the U.S. dollar. A stronger U.S. dollar tends to keep the price of gold lower and more controlled, while a weaker U.S. dollar is likely to increase the price of gold through growing demand. You can also say the same about inflation. As prices for food and gas rise, and as prices rise as the value of the dollar falls, it leads to a higher price point for gold.
Investors in the world of jewellery know this well. As demand for consumer goods such as jewellery and electronics increases, the cost of gold can rise. In 2019, jewelry accounted for approximately half of the gold demand, totalling more than 4,400 tonnes, according to the World Gold Council. While consumer consumption of gold jewellery declined in 2020, the demand from the retail sector is on the rise as the world continues to recover from the pandemic. Returns on bonds, equities and real estate can fall in volatile markets. However, such calamity only increases the price of gold. That’s why gold is often considered a “safe haven” for investors during turbulent times. In addition, gold is regarded as a safe-haven asset to protect during periods of political instability as well.
Gold Demand Trends
Between pent-up demand, holdings in central bank reserves and the value of the U.S. dollar,
all help drive the price of the precious metal. The values of gold stocks can sometimes reflect the cost of physical gold. However, there have been instances when the stock markets rise and gold pulls back. Inversely, gold prices often rise when stock prices fall, making gold an effective hedge in a turbulent stock market. Gold mining stocks are another investment product that some consider being riskier than investing in physical gold. Although some speculation goes on, the rewards outweigh the risk, and substantial returns are often worth it. Gold ETFs are another way to determine demand factors.
Gold mining companies can be speculative investments that aren’t ideal for those who are risk-averse. Like physical gold, gold ETFs are high liquidity and can be traded on the stock exchange. You can invest in the gold market without investing in smaller denominations, which is less costly in comparison to buying gold bullion. Meanwhile, gold futures are financial contracts obligating the buyer to purchase or sell gold at a predetermined future date and price. The main advantage of gold options over futures is the smaller cash outlay and greater flexibility in selecting the cost to hedge.
While supply and demand impacts can significantly influence the bonds and equities market, precious metals like gold often serve as a hedge against inflation and a weak U.S. dollar. Understanding what drives the markets will help you understand one key fact — gold is here to stay, and its value isn’t going down any time soon. Regardless of your investment goals, there are many gold investment products to choose from. Remember to do your research and factor in the amount of risk associated with each investment before making a decision.
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