Despite a significant drop from its September 2011 high of $1896, gold continues to lure investors seeking portfolio diversification and protection against economic uncertainty.
Before making any investment in gold, it may help to understand what drives the growth in its price.
Gold IRA from Capital IRA Partners, or investing in precious metal IRA accounts, differs from investing in stocks and bonds. First, gold is a “hard asset”, meaning that it has intrinsic value. Other hard assets include oil, natural gas, and commercial or agricultural real estate; as well as diamonds and other precious minerals. Since these goods become more expensive as the value of paper currency decreases, they are typically held as a hedge against inflation.
Near the end of World War II, delegates from all 44 Allied nations met in Bretton Woods, New Hampshire, to establish a new international monetary system governed by the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD). Under the agreement negotiated at this conference, participating countries were required to tie their currency to the U.S. Dollar; which was, in turn, convertible to gold at the fixed rate of $35 per ounce. In essence, the United States agreed to back every dollar spent on international trade with a fixed quantity of gold.
In 1971, with the U.S. unemployment rate at 6.1%, and inflation at 5.84%, President Nixon suspended the Bretton Woods agreement, and converted the U.S. dollar to a freely floating exchange fiat currency. The value of the dollar was no longer pegged to gold.
Since then, the conventional wisdom among investors is that the value of gold increases as the U.S. dollar weakens. Although the oft-repeated claim that the price of gold is inversely correlated to the U.S. Dollar doesn’t quite hold up under scrutiny, comparisons between the price of gold and the U.S. Broad Dollar Index over the last 40 years do suggest that the value of gold increases as the dollar weakens, with that dynamic being most pronounced since 2003.
The most likely explanation for this phenomenon is that investors sensing inflation or weakness in the U.S. Dollar convert their holdings to gold; and, as more investors do so, the price of gold increases. Other hard assets show a similar relation with the strength of the U.S. Dollar; but, for a number of reasons, investing in gold coins and bullion has historically been a more attractive (and safer) strategy than oil, natural gas, and real estate.
Other factors influencing gold price include the costs of production, transportation, and increased demand. This last point is especially worth noting, as gold not only has a traditional value in jewelry, but is an important component in consumer electronics. As demand for these products continue to grow, so too will the demand for gold.
Lastly, gold is a finite resource; the mining of which has slowed significantly in recent years. As the “gold rush”of the last 5 years has progressed, gold mine production has struggled to keep up with the demand—resulting in higher costs of production, as well as increased scarcity. According to an article in Forbes earlier this year, gold is currently “priced near its average cost of product and below its margin of production”, making it a value, even at its current high.