In recent months, as investor sentiment concerning the future of the economy has waned, we’ve seen a significant upswing in the price of gold.
The increase in gold’s prices during a time of recession and the decline of other investments may leave some investors wondering what impact gold prices have on the economy.
While the economy affects gold prices — poor economies and inflation contribute to higher prices — gold prices also can influence the economy.
For example, if gold prices are high, that reflects weak investor confidence in the rest of the economy. Even if high gold prices are being caused by other factors such as big buys by central banks, decreased mining output, geopolitical unrest, a high price for gold will likely have a dampening influence on currency rates and may contribute to inflation.
High gold prices can also have an impact on banks and lending. Back during the 1930s people in the U.S. hoarded gold because of their lack of confidence in banks. As a result, the system hovered on the brink of collapse and the federal government had to ban gold hoarding and confiscate gold to get people back in the banks.
However, the more likely scenario is the overall economy having an influence on the price of gold. More than anything, gold is an indicator of how well an economy or a currency is performing.
When currencies aren’t doing well, when inflation is edging upward, investors will flock to gold as a means of preserving their wealth. Gold historically has performed well in tough economic times, and the current stagnant economy has been no exception. In the last four years, gold has more than tripled in price.
There are a number of economic factors that can influence the price of gold, including declining value in other investments and central bank policy. When central banks make big gold purchases, it increases the scarcity of gold and thus makes gold more valuable. Central banks hold a large percentage of the world’s gold, so their moves are watched closely by gold investors.
The question of gold’s role in the economy truly is a chicken or egg-type question, with many believing that the gold price is effected by the economy, and some believing that the economy is effected by the price of gold. As in most matters, the truth is likely somewhere in the middle.
Regardless, investors should watch the price of gold carefully for indicators concerning how well the overall economy is doing. When gold appears to be on a tear, it’s likely a good time to limit your exposure in other securities and add more gold to your portfolio to hedge against a poor economy.
