With gold’s recent boost in popularity and price spikes, more and more investors seem to be considering their precious metal investment options. In order to make a determination as to whether or not investing in gold makes sense for you as an individual, it helps to take a look at the big picture. Understanding the basic variables that impact gold prices is vital to your success as an investor.

by Mark Herpel via Flickr

A Golden Bellwether

Gold has long been a consistent economic indicator with the price of gold signaling how investors feel about the current state of global and U.S. economies. Typically when the price of gold goes up it is an indication that the economy in the U.S. is struggling. Variables that impact the price of gold in this manner include long-term interest rates, rising inflation and a weakening dollar. These are things that veteran gold investors all watch in addition to supply and demand.

The U.S. Dollar

Considered the world’s reserve currency, the U.S. Dollar tends to have an inverse relationship with gold. That means that when the dollar weakens, the price of gold goes up and when the dollar strengthens, the price of gold goes down. The strength of the U.S. Dollar is determined by how well it is trading with other currencies. When the dollar weakens, investors lose confidence and begin to invest more in gold.


The basic concept of inflation is that of a loss of purchasing power. This means that more dollars are required to buy products or services than what were required in the past. When investors believe that inflation is going to continue for a while, they tend to shift more of their money to gold. Of course this increase in the demand for gold causes gold prices to increase. One of gold’s greatest strengths is its ability to serve as a hedge against inflation. One of the variables that contributes to inflation is the printing of money by the government as a way to deal with a financial crisis.

Interest Rates

Another thing that has a direct relationship with the price of gold is market interest rates. When the economy is strong and market interest rates are high, money market accounts, treasury notes and certificates of deposit all provide investors with interest rates higher than the rate of inflation. When the economy struggles, market interest rates drop and these types of investments offer low rates of return, often lower than the rate of inflation. As you can imagine, negative returns are not what investors are looking for and when investors believe that negative returns are right around the corner, they often move their money en masse to precious metals such as gold.

Pros and Cons

One of the disadvantages of buying and holding physical gold is that it typically costs more to store than other types of investments and you pay a premium when you buy it. It also can be a bit volatile due to day trading and other types of more complex investment activities involving Electronically Traded Funds (ETFs).

On the other hand, what you get in return is a reliable and proven way to diversify your investment portfolio. This can protect you from substantial losses in the event of a volatile economic climate or global crisis. As part of a diversified portfolio, gold can help investors weather the storm at times when the value of their stocks and bonds are experiencing substantial decline. Gold prices typically rise when economies struggle.

Investing in physical gold is obviously a personal choice and it should be done in a cautious and informed manner. Understanding the basics of what drives the price of gold can help you determine how much of your investment portfolio you want to strengthen with gold.

Jacob Harrison is a precious metals investment specialist from Australian Bullion Company, Australia’s oldest privately-run precious metals wholesaler and retailer.

Digiprove sealCopyright secured by Digiprove © 2012 Mitch Mitchell
Tweet about this on TwitterShare on Facebook0Share on LinkedIn0Share on Google+0It's only fair to share...