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Gold Breaking the Rules of Supply & Demand Part I: Interest Rates and Inflation

As we discussed in our series opener, Gold is a unique asset in that it breaks free of the supply and demand status quo. Being that gold’s uses vary drastically, it can be difficult for investors to track what factors will actually contribute to driving an increase in the price of gold. In part one of our series discussing what drives shifts in gold prices, we’ll take a deep dive into interest rates and inflation.

Interest rates and inflation play a significant role in the price of gold. Investors are out to make money and choose investments with the highest return. When interest rates are low, so are returns. Low interest rates lead many investors to turn to gold, which historically produces steady returns over time. When this happens, the price of gold increases. However, when interest rates (and therefore returns) are high, investors turn away from gold and to investments that will produce higher returns in a short amount of time – causing the price of gold to drop.

However, high interest rates do not always mean trouble for gold – inflation plays a critical role. The issue with comparing interest rates with gold prices is that the stated/advertised interest rates (known as “nominal interest rates”) do not take inflation into account. In order to get an accurate picture, you must look to the “real interest rates,” which are rates that reflect the actual amount of interest an investor expects to receive after factoring in inflation.

To better understand real interest rates, you must first understand inflation. In times of economic prosperity, the federal government often decides to print more currency. When this occurs, the value of the dollar lessens and the cost of goods rise. In this scenario, gold also rises, functioning more like a commodity than a currency.

In short, gold prices depend on the combination of both interest rates and inflation. Investors that can grasp both the current state of interest rates, as well as how inflation may help or hinder their return will be one step ahead in understanding the expected performance gold’s price.

Stay tuned later this week for part II of our series in which we’ll discuss how specific industries, such as fine jewelry and technology, are impacting gold’s price.  




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