What Are the Fundamentals for Gold?
It is extremely important to understand the fundamentals of the gold market before buying gold coins.
The fundamentals of the gold market play a large role in determining the direction and price of gold, though certainly other factors play a role too, emotional factors in particular. Because of that, it is a mistake to focus solely on fundamentals when analyzing the gold market.
Of course, the basic fundamental factors impacting the price of gold can be classified into two broad categories: supply and demand.
The Supply Side of the Gold Market
Gold is inherently scarce. It has been said that all of the gold ever mined could form a cube just 20 yards on each side. Given that gold has been treasured by man for some 5,000 years, this is truly an indication that gold is indeed scarce.
It takes a great deal of time and effort to obtain gold. Whole nations have been transformed by the lure of the yellow metal, as demonstrated by the great American California Gold Rush touched off in 1849.
But gold is so scarce and difficult to find that the overwhelming majority of men and women who set out to make their fortunes mining or discovering gold failed completely.
Today, it is estimated that, even in a successful mine, it takes ten tons of raw ore to produce just a single ounce of gold.
This scarcity contributes to gold’s value. Man has always coveted objects of rarity. Add to this rarity gold’s beauty and you have the basis for much of the demand for gold.
Today, gold is still being mined around the world, yet demand for gold has been outpacing new supply in recent years, thanks in large part to increased investment demand.
The major (though by no means only) sources of newly mined gold are South Africa, the United States, Russia and Australia.
Newly mined gold is not the only source of gold supply, however. Some of the supply of gold comes from existing above ground stocks being recycled.
Because gold is so durable and valuable, relatively little gold is lost. The overwhelming majority of all the gold ever mined is accounted for.
One source of above ground supplies of gold which has received a great deal of attention in recent years is gold held in official reserves by governments and non-governmental organizations (NGOs).
Much has been made of events in which governments or NGOs have sold off gold reserves. For years it was assumed that this activity would put a cap on the price of gold. In reality, this has simply not been the case.
For instance, the Bank of England began selling off its gold reserves in the late 1990s when the price of gold was still trading in the $300 per ounce range, only to embarrassingly miss out on the more than tripling in the price of gold which ensued. In this case, the price of gold was not only un-capped, but it skyrocketed in the face of the liquidation. Some observers point to this episode as proof that governments are simply not smart enough or savvy enough to employ sound monetary policies.
Another similar example involved the International Monetary Fund (IMF), which began selling off a portion of its gold reserves in a planned, methodical way in the same time frame as the Bank of England.
Potential IMF gold sales were held out as a “boogie man” in the gold market for several years. But, like the Bank of England sale, it was the IMF and not the gold market itself that looked silly in the end. The IMF sold off gold, which was quickly and seamlessly absorbed into the market, only to see the price of gold rise significantly, signaling to the world that the IMF’s timing was simply awful.
The Demand Side of the Gold Market
Because gold is both attractive and useful, there are many sources of demand for gold in the marketplace.
For instance, a major source for worldwide gold demand is demand for fabrication for use in jewelry. This is especially true in India, China and other parts of the Orient, where gold jewelry is not just decorative, but is the preferred method of gold ownership for individuals. In that part of the world, gold jewelry is a store of value and trusted medium of exchange.
In the Western world, gold jewelry is coveted for its beauty, luster and ornate value. Because gold is soft, yet durable, it is extremely useful and popular for fabricating pieces of jewelry.
Gold’s durability, malleability and electric conductivity also make it a very useful industrial metal in today’s high tech world.
It is used in electronic components and computer applications and has even been used to line the cockpits of sophisticated military aircraft.
The final—and perhaps most important—source of demand in the gold marketplace is investment demand. Whereas overall investment demand is smaller than demand for fabrication and industrial purposes, investment demand for gold is important because it tends to be a driving factor for the price of gold.
When investment demand for gold rises, the price of gold tends to rise. This is in contrast to jewelry demand, which often trails off when the price of gold rises rapidly.