Understanding the Gold Rate: Why Is Gold Valuable and What Causes Its Price to Fluctuate?

Investors often buy gold as a hedge against inflation because, unlike the US dollar and other forms of federal currency, the amount in gold in circulation doesn’t tend to change much from year to year. So while paper money reduces in purchase value as more paper bills are printed, gold tends to keep its value as its supply remains fairly consistent.


The Value of Gold


Like other rare metals and natural resources, gold is inherently valuable because of its finite supply. Gold’s limited amounts make its going price rate far more stable than those of paper currencies, such as the US dollar, which are theoretically infinite in supply.


However, unlike other finite commodities with attractive investment characteristics, gold tends to hold purchasing power that is similar to cash. In fact, even countries with a collapsing federal currency will invariably accept payments in gold. The universal value of gold spans geographic regions and cultures and has done so for thousands of years.


The vast majority of countries around the world have a large sovereign holding of gold that they can use as a reserve. The United States alone presently holds roughly 4,500 metric tons of gold as backup to other financial assets that are far more vulnerable to market fluctuations.


Gold Price Fluctuation


Its general lack of price fluctuation make gold a wise investment for people, families, and organizations, as well as governments, who want to insure themselves against market crashes and times of economic recession or depression. Because it is generally uncorrelated with other assets, gold allows investors to retain at least a portion of their wealth when other assets fail.


Supply, demand, and investor reactions to these two factors are the key drivers of fluctuation in the gold rate. Studies have shown gold prices to exhibit “positive price elasticity.” This means that the value of gold increases along with its public demand.


As previously noted, the amount of gold in circulation tends to remain fairly consistent from year to year, increasing at an approximate annual rate of 3 percent. This makes the demand for gold far more reliable predictor of gold rates than supply of gold.


In fact, the increased demand for gold during economic downturns not only helps it hold its value but can actually make it go up in value.


The Bottom Line When It Comes to the Gold Rate


While gold may be more stable than other investment assets, this stability comes at a cost. Over the past two millennia, global gold mining hasn’t contributed significantly to the world’s overall gold supply. But even when demand for gold outpaces its limited supply, its investment growth rate has remained fairly stagnant.


The true value of gold becomes apparent in times of economic hardship. Because gold prices tend to move higher when economic conditions are at their worst, this investment is widely known among financial advisors as an effective tool for portfolio diversification and risk management.