Gold is one of the widely traded commodities worldwide, and the most popular precious metal. The price of gold can fluctuate depending on political, social and economic instability. Trading gold is sometimes referred to as a ‘safe-haven’ by traders because its price is not always affected by governmental decisions or interest rates. If you want to start trading gold, it is important to understand the fundamentals that drive the price of gold. Read on to find out which factors affect the price of gold and learn about the different ways you can trade or invest in gold.
Supply and demand are key drivers of gold prices. In 2019, jewellery accounted for around 50% of the gold demand according to the World Gold Council. Another 7.5% of demand is from technology and industrial uses for gold. As demand for jewellery and electronics increases, the cost of gold can rise.
The price of gold is inversely related to the value of the US dollar
The US dollar has strong influence on the price of gold, mainly because gold is denominated in the world’s reserve currency. When the value of the dollar strengthens, the price of gold tends to fall. Conversely, when USD weakens, the price of gold rises.
Gold is considered to be a ‘safe-haven’ asset. In periods of political instability, gold is often seen as a ‘safe-haven’ investment as it tends to hold its value when other markets fall in price. Therefore, when markets are uncertain, investors often turn to the safety of gold. But when any investment becomes popular, it can push up prices.
Gold and interest rates traditionally have a negative correlation
When interest rates rise, the price of gold tends to fall because investors turn to stocks and fixed-income assets that will earn them capital. When rates fall, the price of gold increases as economic uncertainty causes investors to turn to gold as a safe haven to protect their wealth.
There are different ways to trade and invest in gold. Trading and investing in gold are two different ways to take a position on the future price movement of gold markets.
When you invest in gold, you will have ownership of the asset and you will make a profit if the precious metal rises in price. When you trade gold, you’re taking a position on the underlying price rising or falling. You will not have ownership of the physical gold itself.
There are many types of gold assets available to trade or invest in and these include the following:
- Gold bullion. Physical gold (coins and bars) is commonly used as a store of value for both individual investors and banks. But physical gold cannot be stored as easily as other financial assets and the expensive safekeeping and insurance requirements often deters investors from buying the actual metal.
- Gold CFDs. Gold CFDs (contracts for difference) allow you to open a position without having to purchase the underlying asset. For example, if you open a Buy position you are speculating that the price of gold will rise. If the price rises, you will make a profit on the difference between the opening price and the higher closing price. If the closing price is lower, you will make a loss that is equal to the difference between the opening and closing prices. However, if you think that the price of gold will fall, you can open a Sell position to profit from the opening price and lower closing price. But if the price rises and you close your position at the higher rate, you will make a loss equal to the difference between the opening price and the higher closing price.
- Gold ETFs. Gold ETFs (exchange-traded funds) are commodity funds that have become a very popular form of investment. They provide investors with a low-cost alternative that invests in gold-backed assets rather than the physical commodity.
Investors do not actually own the physical commodity, but they have ownership of small amounts of gold-related assets, providing more diversity in their portfolio. They allow investors to gain exposure to gold via smaller investment positions than what’s achievable through physical investment and futures contracts.
Gold can be a good investment, but it depends on the suitability of gold to your portfolio.
There are both advantages and disadvantages to every investment, and as with all financial assets, trading and investing in gold comes with risks of losing capital.
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