by Tony Davis – Atlanta Gold & Coin Buyers ……….
Ben Bernanke, the Federal Reserve’s Chairman, in testimony before Congress on Thursday made several comments in reference to the price of gold. While claiming not to understand what affects gold prices, he stated that falling gold prices indicate that investors are less concerned about “extreme” outcomes in the economy. He also said that people hold gold as “disaster” insurance, and that gold doesn’t serve well as an inflation hedge. In this article, we’re going to explain what affects the price of gold in hopes that you’ll be able to identify trends before they occur and benefit financially from your choices.
Contrary to Mr. Bernanke’s statements, he seems to have a basic understanding of what causes movement in the gold market, in that he referred to it as “disaster” insurance. As we saw following the global financial meltdown in 2008, gold is the ultimate safe haven. When there is turbulence and uncertainty in the market, there’s typically a flight to quality. Gold, along with treasuries, tend to be the investment options of choice during uncertain times. However, since we’re starting to see upward movement in interest rates, even in light of the Fed’s $85 billion a month bond buying program (http://www.huffingtonpost.com/2013/06/19/federal-reserve-bond-buying_n_3467097.html), treasuries aren’t likely to be the favored asset class following the next global financial crisis.
With respect to its role as an inflation hedge, gold has done surprisingly well throughout the course of history. The following chart from www.macrotrends.net provides the historical inflation adjusted gold (and silver) prices from 1915 through present. As you can see, precious metals have performed well on an inflation adjusted basis. While the compound returns of the stock market have outpaced precious metals since 1915, gold and silver have certainly held their own. From a practical standpoint, how does this affect the man on the street? In the 1930’s an ounce of gold was $35, which could buy you a nice custom tailored suit. Today, the price of gold is nearly $1,300 an ounce, which can also buy a custom made suit. The important factor to consider is that gold maintains its purchasing power over time, making it an ideal inflation hedge.
The Federal Reserve’s monetary policy tends to be one of the best predictors of future gold prices. As we can see from the following macrotrends.net chart, the price of gold closely follows monetary policy. When the Fed inflates the monetary base, as it has since 2008, the price of gold tends to perform well. Since 2008 the Federal Reserve has increased their monetary base by nearly 250%, resulting in a $500 – $600 increase in the price of gold over this time period. When looking at the trend line, the price of gold and the monetary base diverged at the beginning of 2013. If the price of gold adjusts to once again track the monetary base, we could see a significant increase in price from its current levels.
While we would be remiss if we didn’t mention that technical factors, such as short selling, margin calls, etc. oftentimes affect the price of gold, these movements are likely to only have a temporary affect on prices, as ultimately the price of gold is based on supply and demand. Furthermore, the price of gold in the futures or paper market doesn’t necessarily track with the physical bullion market. As noted in the following article from the Gold Anti Trust Action Committee , the premiums on American gold eagles increased to as high as double digits following the global financial crisis. Large discrepancies aren’t unprecedented, and will likely arise in the future when demand in the physical bullion market diverges from the futures market.
In summary, gold serves as a safe haven during financial crises, which are admittedly difficult to predict, at least as to their exact timing. It’s obvious that over the years gold has, in fact, been an excellent hedge against inflation; allowing individuals to maintain their purchasing power. We have also seen that the Fed’s monetary policy affects the price of gold, and lastly, while technical factors can cause abrupt short term price inconsistencies, ultimately the price of gold is determined by supply and demand.
Tony Davis is the owner of Atlanta Gold & Coin Buyers, a full service Atlanta based coin and bullion dealer specializing in buying, selling and appraising coins and coin collections of all types and sizes. Visit his website at www.atlantagoldandcoin.com for additional information on the products, services and educational resources offered by his company. Tony can be reached at [email protected] or at 404-236-9744.