Gold at Any Price? Why Is This Precious Yellow Metal Breaking Records?
Gold has been used as a commodity for thousands of years. Since the beginning of 2020, gold has risen by almost 35% and reached an all-time high on the New York Stock Exchange.
1. Why are gold prices hitting new highs recently?
2. How long will prices continue to soar?
3. How does the gold market work?
4. How do you invest and trade gold?
Since the beginning of the year, and with the help of COVID-19, the yellow metal to more than $2,000 an ounce (31.1 grams).
1. Why are prices rising at a meteoric pace?
2. How is the gold market working?
Below is an overview that gives answers to important questions that we are all asking:
Where Does Gold Come From?
Gold ore comes from rocks in underground mines all over the world. According to the US Geological Survey, China has become the largest mining power, with 420 tons in 2019. Other sources are Russia, Australia, and the USA.
Toxic cyanide solutions are used to dissolve gold from the crushed rocks. Then, the metal is distilled into impure ingots called doré- a semi-pure alloy of gold.
The ‘doré’ is sold to refining companies, which turns them into pure gold, close to 99.99%.
The refining companies play another essential role – gold recycling.
According to the World Gold Council, a quarter of the refining demand comes from recycled gold, mostly recycled jewelry. Because of the rising prices and the need for cash, people are selling their gold.
What Is The Gold Market?
There are two gold markets.
1. Physical Market:
In the physical market, we have gold refineries, processors, jewelers, central banks, electronic manufacturers, local banks, and investors. The center location of this market is in London ever since Brazil’s first-ever gold rush in 1697. However, London is not alone. Shanghai, Zurich, Dubai, and Hong Kong are also hotspots.
2. Future Contracts:
Trading and prices are done electronically in the COMEX Stock Exchange in New York. COMEX gives investors invitations to speculate on the rising or falling of gold prices without holding any gold. They also provide mining companies the possibility to hedge themselves against unexpected gold prices.
The major investment banks are active in both markets. That makes the two markets act almost the same.
The Bank of England keeps more than 400,000 gold bars under a narrow street in the City of London. Interestingly, many gold bars are stored for the UK government and other central banks. However, the biggest gold bars are stored by the New York Federal Reserve Bank.
Gold prices are quoted in troy ounces. There are 14.6 troy ounces per pound, instead of the usual 16 ounces, and each gold bar weighs 400 ounces.
Prices in London are set at auctions twice a day and serve as a benchmark for the entire physical market. When a watchmaker buys gold from a gold refinery, they pay market price, the London auction price plus X% percentage.
To avoid paying millions of dollars for tons of gold, industrial users tend to borrow gold instead of buying. Banks lease them the gold and charge interest, lend to the futures market, or swap and repurchase transactions.
How Does The Financial Market Work?
Future contracts lock the gold prices that will change hands on a specific date. Buyers and sellers agree to exchange 100 troy ounces. Data for gold contracts go back to the last days of 1974 when COMMAS allowed Americans to hold gold bullion for the first time in 40 years.
Most trades are future contracts and not a physical gold exchange. Recently, more investors have been receiving gold deliveries – a sign that demand for physical gold is unusually high.
How Is The Interaction Between The Physical Market And The Contract Market?
In good times, gold costs about the same in London and New York. If prices go wild, banks “reset” them by buying cheap ingots in London, flying them across the Atlantic, usually in the trunk of a passenger plane, and selling them at a profit where prices are higher.
They must consider losing a small amount for melting and resizing the bar to 100 troy ounces or one pound in order to comply with the COMAX weight requirement.
March, the beginning of the COVID-19 pandemic, disrupted the self-correction of the gold prices. The lack of flights led to fears of a shortage of gold in New York, sending contract prices above gold prices in London. The concerns turned out to be unjustified, but price fluctuations led to losses for banks like HSBC. Banks reduced trading in COMAX and made contracts more volatile.
How Do Investors Buy And Sell Gold?
Professional fund managers bet on gold prices with contracts. To avoid holding large quantities of gold bars, traders sell their contracts before they expire and buy new contracts for a later date, a rollover process. This type of trading has a price; longer contracts cost more than the spot contract which calls for immediate delivery.
Contracts are based on what “I believe the gold will cost at a particular date,” and the actual price on that date.
For example, You buy a contract to buy gold on December 20, 2020. You agreed to pay $2,100. On December 20, the gold price closed at $2,400. That means you made $300 because your contact allowed you to buy at $2,100. This also works the other way around. For example, if the gold closed at $1,900, you lost $200.
Small investors buy physical ingots and coins. Ounces of gold-plated eagle coins manufactured by the U.S. National Coin and sold by merchants like Kitco Metals are among the most popular.
Demand for gold bullion and coins has risen during the COVID-19 pandemic despite the price. Gold owners had an opportunity to sell their gold for a nice profit.
However, this has not always been the case. In 1933, during the Great Depression, Franklin Roosevelt ordered Americans to transfer all gold coins, denominations, and certificates of ownership to banks to prevent banknotes’ conversion into gold.
Investors who want exposure to gold prices without the headache of storing ingots or trading contracts found an alternative solution in 2003 using Gold ETFs, Exchange-traded funds.
These funds, which are gaining popularity, are buying gold and issuing shares and certificates that traded on the stock exchange. According to the World Gold Council, ETFs bought a record of 734 tons of gold in the first half of 2020 and their total holdings rose to 3,621 tons of gold.
This type of purchase offset a 46% drop in jewelry sales, a popular method of investing in gold in Asia. India and China led the decline, which the Gold Council attributed to store closures, economic uncertainty, and higher prices.
Why Are Gold Prices Soaring?
The main reason for the rapid increase in gold prices is the quick decline in U.S. Treasury bonds. This produces stress levels for the expected rate of inflation. Unlike bonds or bank deposits or stocks, holding gold does not offer any income. Gold holding is a miss of returns from assets that pay dividends or interest. When profits are negative, gold is an advantage. The Federal Reserve’s decision in March to cut interest rates to almost zero and buy bonds by hundreds of billions of dollars lowered bond market yields. That motivated investors to buy gold.
Some investors buy gold because they think it will retain value if stocks fall again. Gold enthusiasts go one step further, arguing that gold is the ultimate insurance certificate against the possibility of insolvency or inflation to reduce the debt burden.
“Gold is a safe haven,” says Rhona O’Connell, chief analyst for Europe, Middle East, Africa, and Asia at StoneX Group. “There are no political or financial risks associated with it.” Another coefficient of gold these days is the dollar’s weakness. Low dollar value makes gold cheaper for investors from other countries. This relationship is not always maintained: gold and the dollar rose together in March, during the turmoil in the capital markets.
Is It Different From Previous Periods Of The Bull Run?
Two gold price runs occurred since President Nixon abolished the peg of the dollar to gold in 1971. The most dramatic run encompassed the 1970s. The oil prices led London gold prices to soar from $43 an ounce to a high of $850 in the early 1980s.
Prices soared again in 2008-2011 when interest rates plummeted because of the Federal Reserve System’s aggressive incentives and the recession. Concerns that the purchase of bonds by the central bank will ignite soaring inflation also contributed to the dollar’s rise.
Will Prices Continue To Rising?
It took three years from the outbreak of the previous financial crisis for gold prices to reach a record high. Prices continued to rise until it was clear that the American economy would recover slowly, and there would be no inflation. The history of the gold market indicates that gold prices tend to go up too much. Gold prices may rise to a higher level than before the pandemic due to institutional investors adding to their gold holdings, along with the returning to jewelry shopping in China and India. The most significant downward factor could be the real interest rate trend.
Is Gold A Commodity Or A Currency?
It is both. Gold is a commodity whose value derives in part from its use in products such as jewelry. Physical banks are actively trading gold in their commodity books, and the Commodity Futures Trading Commission oversees the U.S. contract market. Gold is treated the same as other commodities. Gold is shown on the bank’s balance sheets as other commodities to prevent a 2008-2009 financial crisis.
In any case, gold is also a currency. For thousands of years, gold metal has functioned as an item of value, a unit of calculation, and a means of exchange. The Egyptians melted gold bullion as early as 4000 BC. Gold played a fundamental role in the monetary system in 1717. Isaac Newton, the director of British currency, established a trade relationship between gold and silver metal until 1971. President Nixon completed the conversion of the dollar into the precious metal at a fixed rate. Although gold has ceased to be the exchange rate base, it still plays a role in currency markets. For example, central banks in emerging countries have increased their gold holdings in recent years in an attempt to reduce their dependence on dollars.
Gold is more of a currency than a commodity. To one degree, everything traded by someone may not return to the market. Gold remains in the market.