Thursday, July 22, 2010

Understanding the Gold Market

If anyone has been paying attention, I am sure you have noticed the discussion about the current gold market and its sky rocketing prices. In the past few months gold has been reaching record heights of over $1250 and ounce.  There are many factors at play that have caused this rise in the market.  The gold market is tied into the global economy and money supply. It is in demand as a luxury item,
industrial material, and as an investment.  Supply is affected by mining production and the rate that recycled gold reenters the market.  The market can be volatile and predictions range as to what the gold market will do next; however, many experts are predicting that gold will continue to rise to even greater heights in the next 5 to to 10 years.

The first explanation as to the current state of the gold market lies with gold's positive correlation to an increased global money supply and our current global economic situation. There are two situations that can cause an increase in monetary supply and both can result in an increase in gold prices.  An increase in monetary supply can occur as a result of economic growth.  Increased general wealth means that there is more disposable income to be spent on luxury items such as jewelry and gold causing a greater demand for these products.  The second scenario is more closely matched to the one we currently find ourselves. If there is increased money supplies and little to no economic growth, this causes fears of inflation and causes investors to find safety by investing in hard assets.  Since 2007 we have been in the midst of an economic downturn in the United States and worldwide. The most recent financial crisis occurred in Europe where the European Union approved an unprecedented $1 trillion dollar loan package for emergency loans, bail outs, and IMF support. As the euro fell 12% against the USD, the global stock market took a big hit. In the wake of this economic melt down, governments across the globe have instituted policies to soften the economic blow and to attempt to create some recovery.  One of these strategies is quantitative easing.  This is a monetary policy that is used to increase money supplies and therefore stimulate a stagnant economy.  Central Banks purchase assets from financial institutions using money that they have ultimately, created out of nothing.  This strategy has the potential to backfire by devaluing currency and causing inflation. As the global money supply increases with little economic growth, fears of inflation increase causing investors to turn to hard assets, such as gold, to protect their wealth.  People are seeking the safety of gold in a market where currencies are falling and fluctuating.  This has caused the gold market in Europe to take off. It looks as though gold is benefiting, as it represents some stability to investors in an unstable market. 

It is impossible to look at the gold market with out taking on a global perspective because, the global demand for gold is very diverse. Over that past 5 years, the largest global demand for gold came from jewelry and more than 50% of this demand came from India, China, Turkey, and the Middle East. Demand for investments only accounts for about 20% of demand coming mostly from India, Europe, and the United States and only 12% of demand comes from industrial needs, mostly from Japan.  To understand the gold market fully it is important to look at the global influences.  Since the gold jewelry market creates the largest demand, we will look briefly at what influences are at play.  Jewelry demand tends to fluctuate seasonally brought on by various holidays and celebrations around the world.  The fourth quarter usually results in the highest gold jewelry demand.  This is caused by the occurrence of end of the year celebrations, Christmas, and Diwali.  The 1st quarter usually lends the second highest demand due to the Chinese New Year, National Day, Valentine's Day, and the Italian Wedding Season.  India has the largest market for gold jewelry with the U.S coming in second.  Jewelry demand is also expected to stay strong in China and India in the coming years

Another factor affecting the fluctuations of the gold market is supply.  Gold can be mined from every continent on Earth except for Antarctica where it is prohibited. In the past several years mining output has leveled off and supplies have actually fallen in 5 of the last 8 years.  This is due to a decrease in spending and exploration. With investments increasing and jewelry consumption expected to jump 19% this year, it is a simple situation of supply and demand.  Demand has been increasing while supply has been staying relatively constant. In addition to new production driven by mining, much of the gold in circulation comes from recycled gold.  Recycled or scrap gold plays an important role in the gold market and represents approximately 1/4 of the gold supply.  Since gold is virtually indestructible, in theory, all of the gold ever mined still exists today. Recycled gold comes mostly from jewelry and only applies to jewelry that has been melted down refined and turned back to gold bars. Because the gold price has risen so high, imports have decreased in some areas making recycled gold an important addition to keep up the flow of supplies.

Because of the increases in the current gold market, many people have decided that now is a good time to sell.  Gold prices have reached all time highs over the past several months due to numerous factors including the current global economic situation and the increase in global monetary supply. Many people who are in need of extra income in a rough economic time, are turning to their own gold possessions and are thinking about selling.  With prices higher than they have ever been, and for those who don't want to risk a possible down turn in the future market, now is the perfect time to sell (granted one has done their research and has found a reputable company to sell to).  Predictions as to how far this current market will rise are wide spread.  Some are unsure how much further the market can push before reaching its ceiling while others predict that among this economic uncertainty, that gold will continue to $2,000 an ounce or higher.  Either way it seems that things are bright for gold right now whether you are buying or selling and with a market that is influenced by such a wide variety of factor in a changing global market it is hard to tell where the gold future lies.

2 comments:

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