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Gold is in the news again summiting new heights each passing day. The last few months have been detrimental for consumers as its value has soared. The bullion recorded $2,431.77 per ounce on April 12, the highest level achieved. However, by the time this article is published, it would not be surprising if gold breaches this level and attains even greater heights.
Gold has long been assumed as a protector of wealth becoming an attractive prospect for traders during turbulent times. However, the price movement reveals more than simply acting as a hedging tool against inflation.
Economic Forces
As an asset, similar to stocks or financial instruments, gold responds to the fundamental forces of supply and demand. Inflation is essentially interpreted in a negative context due to the higher prices paid by consumers. However, it is not just present in the prices of consumers. When inflation rises, the purchasing power of a currency falls which contributes to the increase of certain assets. Likewise, traders pursue assets that either appreciate or maintain value. Since the bullion is scarce, durable and has an intrinsic value, it has achieved the status of an alternative asset. The price hike during inflation is not the only reason for the safe haven tag.
Interest Rates and Inflation
Asset classes are inevitably influenced by inflation. However, real interest rates, nominal rates adjusted after inflation, are critical factors. When the central bank of the USA, the Federal Reserve, chooses not to increase interest rates to offset the rising inflation, real interest rates tend to drop. Lower interest rates reduce the opportunity cost of holding gold thereby offering no yield. As a result, gold becomes attractive to traders not just as a hedge against inflation but as an asset that appreciates in an environment where traditional income-generating investments yield less in real terms. This phenomenon reflects the behaviour of other assets during periods of low-interest rates.
Reaction of Assets to Inflation
When the value of properties and rental income increases, real estate may benefit while the cost of borrowing to finance property purchases in some cases remains relatively low. Likewise, share prices can also climb as organisations pass on inflated costs to consumers, possibly increasing earnings and making investments in shares more appealing.
On the contrary, the response of gold to inflation and interest rate policies is driven by a set of unique factors. Unlike the real estate market, the yellow metal does not generate income through rent or dividends, investing relies more heavily on capital appreciation.
Impact of Geopolitics and Investor Sentiment
Factors including trading sentiment, geopolitical events, currency values and other macroeconomic aspects can drive the appreciation of gold. While the US central bank’s policies are heavily influential, the global nature of the market means that it is not the sole determinant of the yellow metal. Economic growth rates, central bank policies apart from the US and technological advances in gold mining and recycling can shape gold’s supply and demand dynamics in the ensuing future.
Conclusion
The key to leveraging trading in gold effectively lies in understanding the broader context including the policies of central banks and their implications for real interest rates and inflation. The association between gold prices, inflation and interest rates highlights the dual nature of gold as a traditional hedging instrument against currency devaluation and an asset receptive to macroeconomic policies and trading behaviour patterns. The appeal of gold during uncertain and turbulent times including periods of low real interest rates, mirrors its status as a valuable component of a diversified investment portfolio.
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