Sep 29, 2018

Demand Drives gold

Demand Drives gold

Investopedia has been attacking the stereotypes associated with the gold industry and in this article, J.B. Maverick says the equation dictating the gold price is not complicated.

The price of gold is ultimately not a function of interest rates.

Like most basic commodities, it is a function of supply and demand in the long run. Between the two, demand is the stronger component.

The level of gold supply only changes slowly, since it takes 10 years or more for a discovered gold deposit to be converted into a producing mine.

Rising and higher interest rates may in fact be bullish for gold prices, simply because they are typically bearish for stocks.

It is the stock market rather than the gold market that typically suffers the largest outflow of investment capital when rising interest rates make fixed income investments more attractive.

Rising interest rates nearly always lead investors to rebalance their investment portfolios more in favor of bonds and less in favor of stocks.

Higher bond yields also tend to make investors less willing to buy into stocks that may have significantly overvalued multiples.

Higher interest rates mean increased financing expenses for companies, an expense that usually has a direct negative impact on net profit margins. That fact only makes it more likely that rising rates will result in devaluations of stocks.

With stock indexes are making all-time highs, they are always susceptible a significant downside correction.

Whenever the stock market declines significantly, one of the first alternative investments that investors consider transferring money into is gold. Gold prices increased by more than 150% during 1973 and 1974, at a time when interest rates were rising and the S&P 500 Index dropped by more than 40%.

Given the historical tendencies of the actual reactions of stock market prices and gold prices to interest rate increases, the likelihood is greater that stock prices will be negatively impacted by rising interest rates and that gold may in fact benefit as an alternative investment to equities.

So while rising interest rates may increase the U.S. dollar, pushing gold prices lower (gold prices are denominated in USD), factors such as equity prices and volatility, coupled with general supply and demand are the real drivers of the price of gold. 

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