Why Gold Prices Go up When the Economy is Going Down

 A combination of investor behavior, supply and demand are largely responsible for the movement of gold prices. While this seems simple enough at surface level, these factors sometimes work together counterintuitively. For example, many investors view gold as a good inflation hedge. This seems very plausible, especially considering how the value of fiat money reduces the more it gets printed, while gold remains relatively constant in supply.

From year to year, gold mining hardly adds much to the overall supply of gold. This begs the question, why do gold prices rise during a recession?

Supply Factors

Unlike commodities like coffee or oil, gold and other precious metals are not consumed. While people mine more gold each day, nearly all the gold that we have ever mined is still in existence. Judging by this, we should expect gold prices to decrease over time since its supply keeps on increasing. However, this is not the case.

Besides the continually increasing number of people interested in buying gold, we may derive some clues from jewelry demand. Gold purchased in the form of jewelry often ends up in the buyer’s cabinet, effectively withdrawn from the market for several years at a go. 
 
However, gold that is traded on the markets typically needs to come from an accredited source, meeting strict guidelines for quality of refinement, purity, and where it has been sourced. Achieving accreditation can be quite valuable for a gold refinery, with Australia’s ABC Refinery being a recent example in gaining CME Group accreditation.

Value Retention

An impressive aspect of gold is its ability to retain value. For a better perspective, we can compare the wages of a modern US soldier to the wages Roman soldiers used to receive 2000 years ago in terms of gold. The average Roman soldier received roughly 2.31 ounces of gold as annual remuneration. 
 
Assuming a value of $1600 per ounce, Roman soldiers received roughly $3704 annually. In comparison, US Army privates receive about $17,611, which translates to approximately 11 ounces of gold. This metric alone reveals a 0.08% annual investment growth over 2000 years.

Central Banks

Central banks play a significant role in gold price fluctuations. During periods when the economy is relatively stable and reserves for foreign exchange are huge, central banks typically try to minimize the amount of gold bullion they hold. They do this because gold, unlike money in deposit accounts or bonds, is a dead asset that generates no returns.

Central banks face the dilemma of diminishing interest in gold by investors during this period. Therefore, central banks often find themselves on the losing side of the gold trade, despite selling gold being among their responsibilities.

People who know the gold industry can be, to excuse the pun, worth their weight in gold. Movement of highly-sought professionals is common within the industry as the major players position themselves for maximum value in the market.

Portfolio Considerations

A good question some investors ask themselves is, “what is the rationale for purchasing gold?” They ask this question because, contrary to popular belief, gold is not an effective hedge against inflation. However, when viewed as a single asset in a broader portfolio, gold becomes a reasonable diversification option. This, therefore, calls for understanding gold’s strengths and limitations.

The total amount of gold ounces held by an investor should fluctuate relative to the prices. For instance, if an investor would like 2% of their portfolio to be gold, then they should consider selling their gold as the prices rise and buying when the prices plummet.

The Bottom line

When analyzing gold prices, it is usually an excellent idea to consider the performance of certain countries’ economies. Remember, gold is not tied to anything else and can be suitable for portfolio diversification in small doses. Therefore, gold prices will typically rise as economic conditions deteriorate. 
 

 

 
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