Gold is one of the world’s most coveted commodities that is actively being traded in the global markets. Commonly used as a hedge against inflation, it is my opinion that gold will always increase in price over the long term regardless of most economic situations. In this article, I plan to reveal to you the reasons why I believe this.
Economic Scenarios and Gold Prices
Gold tends to always increase in price over the long term under almost all economic situations. The best way for me to explain how this is so, is to categorize all economic scenarios into three groups. Those three groups are economic contraction, economic stagnation and economic growth.
First I will cover why gold prices will inevitability increase under economic scenarios that are congruent with economic contraction.
When an economy experiences economic contraction, the price of gold will typically increase. Why? Because gold is seen as a financial safe haven during difficult and uncertain times. The demand for gold will increase when people are losing their employment, when businesses are failing, when there is a slow down in production and manufacturing, when there is a decline in demand and when there is an overall slow down in economic activity. When times are bad, gold prices will rise.
Let’s not forget about the central banks. When an economy is contracting, the economy’s central bank will take steps to be as accommodating and supportive to an economic recovery as possible. That usually means the central bank will increase liquidity in the financial markets and economy. By doing so, the central bank will make money and credit easier to obtain. When an economy’s money supply increases, it devalues the money and thus gives way to inflation. When inflation increases, gold prices rise even further.
When an economy is experiencing economic stagnation, gold prices will still increase. The rate at which gold prices increase however may decline, but price will still move higher over the long term. You may be thinking, why would gold prices increase during economic stagnation. Gold prices will increase pretty much for the same reasons why gold prices increase during economic contraction. When investors feel nervous and uncertain about the economic outlook of their economy, many will start reallocating their capital to gold because, as I said earlier, gold is viewed as a financial safe haven.
When there is no jobs being created or lost and overall economic activity seems flat, that can be and is often interpreted as a highly uncertain time. Will the economy slip into a contractionary spiral or will the economy improve? This uncertainty is what provokes investors to funnel their capital into financial safe havens like gold. What about the economy’s central bank? The economy’s central bank will most likely still be implementing accommodating monetary policies which would make money and credit very accessible. That coupled with low investor confidence would drive gold prices higher.
What happens to gold prices when an economy is experiencing economic growth? It seems logical for gold prices to contract when the economy is thriving for there would be less incentive for investors to put money into financial safe havens. But that may not be the case. Gold prices would depend on the stance of the economy’s central bank.
If an economy is experiencing economic growth and inflation is low, then there would be a high probably that the central bank would implement expansionary monetary policies which would aid in further growing the economy by making money and credit more available. Now here is the key factor. If the money supply of an economy grows faster than the rate of growth an economy is experiencing (growth in the production of goods and services), then gold prices will increase. If the money supply of an economy grows at the same pace as the economy grows, gold prices will increase at a much slower rate or may even become flat (temporarily).
The Economic Scenario that Causes Gold Prices to Decline
There are some situations that will cause gold prices to fall over the short to medium term. One such scenario is if an economy is experiencing economic growth with high inflation (or even hyperinflation), the economy’s central bank will be prompted to implement contractionary monetary policies. By doing that, the central bank will be removing money and credit from the system.
Because the economy is growing and the money supply is decreasing, the purchasing power of the currency will increase and thus gold prices will fall. The rate at which gold prices fall will depend on the rate of economic growth the economy is experiencing and the intensity at which the central bank is implementing its contractionary monetary policies. If contractionary monetary policies are too severely implemented in an effort to accomplish disinflation, then deflation could take hold and gold prices will fall even further.
Let’s not forget, a central bank wants to enact expansionary monetary policies so that it is as accommodating as possible for economic growth. If too much inflation starts to manifest, then a central bank will do all it can to quickly neutralize the threat. Once the threat is neutralized, the central bank will want to start implementing expansionary monetary policies once again. It is in that fact, where gold prices will ultimately head higher over the long term under economic growth conditions. Don’t forget, the rate at which gold prices increase will depend on how quickly the economy’s money supply increases respective to the economy’s growth.
The Supply and Demand of Gold
I truly believe that gold prices will always head higher over the long term relative to any currency. But it is possible that some key supply and demand factors may change that would cause the opposite to occur. One such factor would be a change in the supply and or demand of the commodity. Let’s say that the global markets found a one billion tons of gold in a cave somewhere. That would drastically increase the supply of gold in the markets and thus cause the price of gold to fall substantially.
It is also possible that investors worldwide no longer want gold for whatever reason. That would drastically decrease the price of gold as well for it would cause a drop in demand for the commodity. Supply and demand factors definitely play a role on determining price action for gold. But due to the fact central banks tend to create money at a faster pace than gold is mined, gold prices will always continue to increase over the long term.
Central Banks & Low Inflation
Central banks all around the world aim to achieve some amount of inflation. Usually they will try to meet an annual inflation rate of 2-4 percent. This fact also supports my belief of why I feel gold will always increase in price over the long term.