What Affects Gold Prices

Like all assets the price of gold is affected by its supply and demand. Much gold that is used is what we already have compared to what is mined every year. Hence supply has very less to do with the price of gold. Demand plays bigger role in change in gold prices.

Demand for gold comes from individuals, industries and central institutions. Gold is used for consumption by retailers and industries. It is used for savings, investment and as a hedging tool by investors, financial institutions and central banks. Factors that affect the price of gold are discussed below.

Demand for jewelry

Jewelry accounts for the largest demand for gold. Close to 65% of annual world gold demand is for jewelry. If recycled gold is excluded, about 80% of gold mined every year is used for making jewelry! Like you guessed, India is the largest consumer of gold jewelry. Indians have historically had a penchant for gold. India alone makes for about one-third of the market for gold jewelry. According to a World Gold Council estimate about 20,000 tonnes of gold is stored in households in India-this is three times what USA holds in its federal reseve!

Demand for gold jewelry is high seasonal in India. There is a surge in sales during Dhanteras just before Diwali and Akshaya Tritiya in May. The price of gold peaks during the two festivals. Most gold purchase is made for wedding occasions. According to World Gold Council over 50% jewelry in India is bought during weddings.

Gold also has manifold industrial uses owing to its many properties conducive to use in the fields of electronics, automobiles, space, medicine and dentistry. But this accounts for just a small portion of the total demand- about 10% annually.

Currency fluctuation

Gold price like other commodities has negative correlation with currencies. What this means is when the globally traded currencies are high in value the price of gold falls. In India much gold is imported. As US Dollar appreciates in value with respect to Rupee, gold becomes expensive. Similarly when Rupee appreciates, the price of gold in India comes down.

Central bank actions

Central banks like the RBI play an important role in affecting the price of gold. Central banks hold a portion of their reserves in gold. Bulk buying or selling of gold by these central banks can change the price of gold not only in that country but also globally.

Gold is considered as hedge against inflation. If the US economy or the Eurozone are facing economic crises the RBI might be interested in decreasing the weight of US Dollars, Euro, Sterling, etc and replace that by gold in its foreign exchange reserve.

Another way in which central banks end up affecting the price of gold is through interest rates. When domestic interest rates are high people are less inclined to seek better returns through investment in gold. On the other hand when interest rates are low investors turn to gold, raising its price.

The government can also play role by changing duties on gold. To discourage buying gold it can increase customs duty on gold.

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