Often you hear gold as an inflation hedge or Gold Prices as it relates to the dollar. There is good reason for these assertions though they don’t tell the whole story. More often than not Americans look at gold as it relates to the different aspects of the US economy, including the stock market, United States inflation, or US Gross Domestic Product (GDP). There is more to the importance of gold for a person’s portfolio than just the United States. From 2004 to 2008, the demand for gold around the world consisted of only 11% from the United States. That is 89% of the demand for gold that has to be accounted for to understand its true potential.
The global demand for gold has many layers. For the last 5 years, jewelry has consisted of 68% of the overall demand for gold. The major players for gold jewelry with over 50% of the demand are China, Turkey, and the Middle East. Gold, as gold coins or bars, adds another 20% of the demand where the United States, India, and Europe play a vital role. Industrial demand lead by Japan makes up the last 12%.
You miss the whole picture when only correlating the price of gold to the economic situations in the United States. Inflation, money supply, and the velocity of money around the world all play a pivotal role in the price of gold. Understanding the fundamentals of gold prices from global economic situations gives greater context to the future behavior of gold. It is important to focus on the top countries that affect each aspect that drive the demand for gold.
Money Supply and Gold
Over the years, gold has shown to have a low correlation to many different financial assets. This includes during both bull and bear markets for stocks and real estate. There are however important correlations to understand that do affect the price of gold and its behavior for both the short-term and the long-term.
One of the top correlations of gold prices is to the dollar. As gold has a negative correlation, which means as the value in the dollar drops gold prices typically increase in value. Gold has also been known to outperform the stock market and bonds during times of inflation. During the current economic crisis since 2007, gold prices have increased in value each year. All totaled gold has increased in value for 9 years in a row as of the end of 2009.
When investigating reasons why there is in an increase in the money supply, it is important to remember the earlier note about understanding the global money supply. There are two key reasons that create an increase in the supply of money. First, an increase in the money supply may result from a growing economy. This reason will typically not lead to higher inflation. Secondly, when central banks add liquidity into the markets by printing money to stimulate the economy increases the chances of an inflationary period. This is one the major issues facing global economics currently which started with the financial crisis in 2007. The exact extent of inflation is impossible to predict though similar monetary policies throughout the years have created periods of higher inflation.
The reality is, a positive relationship between gold prices can occur no matter the reason for an increase in the supply of money. During times of economic growth there is an increase in wealth which leads to higher demand for luxury goods like gold. During times of economic recession, gold can be used as an asset that protects against inflation and devaluing paper currencies. Gold is considered an asset more than an investment as you have physical ownership of it, and no matter its form including jewelry of gold coins the value has never been zero.
As conditions and the markets change over time, it is important to understand gold’s relationship to the current monetary policies and current economic conditions. By focusing on the entire demand for gold you can create a better decision on whether now is a good time for you to buy in relation to gold prices.