What's Wrong with Gold?

Ryan Bhandari |

Goldmember.jpg

Isn’t it fascinating that something with absolutely no intrinsic value can be so valuable? I mean, what can you do with gold other than look at it? It can’t be used as a means of production, or converted into anything useful in society. At one point, dollars used to be convertible into gold, so it was basically an alternative currency, but that’s no longer the case either. So what is gold good for?

Gold has always been the currency of choice for many people around the world. The reason behind it is relatively simple. Among the 92 naturally occurring elements on Earth, gold is the most logical one to use as a currency. You can’t use gases, halogens, or liquids. Similarly, you don’t want to use poisonous metals like arsenic or radioactive elements like uranium. That eliminates about half of the elements right away. You want a metal that doesn’t corrode and rust. And you want a currency that can meld relatively easily to create different quantities used in exchanges for goods. And finally, you want a currency that’s rare, but not too rare. Essentially, gold is the best fit. Therefore, it has been used throughout history as a currency and a medium of exchange. But with the invention of fiat currency, using gold for currency became an irrelevant and useless proposition for a variety of reasons that aren’t worth discussing right now. Now, though, gold is a commodity traded in the markets.

Like any metal or element that has no intrinsic value, gold is vulnerable to shocks in the market. Its price is largely dependent on the demand for the good and how much new gold is added to the existing supply each year. Of course, there are other factors that make up the price of gold. So in this article, we’ll try to figure out why exactly gold has decreased so much in value recently, and try to determine if this drop in price is just a temporary blip or a more long-term, permanent trend.

The Fall

When the recession hit the United States in 2007, gold was climbing in price and continued to do so even after The Great Recession had technically ended. Gold went up from $400 an ounce in 2005 to over $1,800 an ounce in 2011. Since that peak though, the price has steadily been declining. The last six months alone have been particularly tough for gold bugs. In January of this year, gold was trading at around $1300 an ounce. Today, it’s trading around $1090. Gold has lost 16% of its value in six months. Since its peak in 2011, gold has lost about 40% of its value.

Why Has Gold Fallen So Much?

Gold fluctuations in the market are complicated. One of the biggest factors on the price of gold is the relative strength of the dollar. As the dollar increases in value, gold tends to decrease in value. This is partially because investors reevaluate the price of metal in response to different currency movements.

Gold is also very sensitive to interest rates. The price of gold isn’t being helped when the Federal Reserve consistently drops hints that they are going to raise the federal funds rate to 0.25%. Gold provides neither a dividend nor an income, so when markets improve, interest rates rise and returns on other investments tend to increase as well.

Also, if global markets are in catastrophe, gold tends to go up in price. This is most likely why gold shot up so much after The Great Recession. Greece being saved by the rest of the Eurozone helped add stability to international markets, which kept the price of gold low.

What About the Gold Bugs?

Literally by definition, gold bugs are always bullish on the prospects of the precious metal. But the metal has been losing value consistently for nearly four years. Now is not a good time to be a gold bug: The markets have been growing every year since we’ve come out of The Great Recession, and the world’s economies are also relatively stable for the moment (other than Greece).

However, there is speculation that the market is overvalued right now. P/E ratios in the S&P 500 are very high, and there is a fear that share prices are going to “pop.” If this were the case, then gold might to start to increase in profit. Performance of the market and price of gold are usually inversely correlated.  

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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