The Fundamentals Behind the Price of Gold

Inflation is sky high, war is raging in Europe, and stock markets are collapsing. It would seem the timing is perfect for gold. So how come the precious metal is merely holding its value, rather than soaring?

Rising prices, global tensions, and financial turmoil all are bullish for gold, which has been a reliable safe haven investment for centuries. Indeed, the price of gold did jump more than $200 an ounce during the first nine weeks of the year. But since then, other factors have influenced the price of the precious metal, which investors should take into account.

First, interest rates have been rising steadily, as the Federal Reserve Board has clearly communicated its intent not only to continue pushing short-term rates higher but also to reform its dollar-printing ways by withdrawing funds from the financial system. To some investors, higher interest rates increase the attractiveness of bonds relative to gold since gold does not pay interest. (This, however, can be a losing trade for anyone not holding a bond to maturity because bond prices decline as rates continue to rise—and they’ve dropped steeply this year.)

Rising U.S. interest rates also boost the value of the U.S. dollar, especially since rates have been extremely low, even negative, overseas. A stronger U.S. dollar is fine for Americans, but not for foreigners seeking to buy items priced in dollars—and the benchmark price for gold, around the globe, is in U.S. dollars. That makes gold more expensive in its largest markets, which are overseas.

Another factor to consider when stock markets are tumbling is the fact that some investors will need to liquidate assets that still hold value, which can create selling pressure on gold. This is especially true for investors who have borrowed from their brokers to buy stock (what Wall Street calls “buying on margin”) and face margin calls as the value of their stock declines, forcing them to sell assets like gold.

For these reasons, it can be challenging trying to generate short-term profits by trading gold, even in a bullish environment. The safest and smartest approach for most investors is to buy gold and hold it for the long term as a secure investment that will hold its value through both good and bad times.