What is the true price of gold and what are the factors that help determine this?
Gold advocates have long believed that when currencies are not on a gold standard the equilibrium price will ultimately be found, as there is an inexorable link between the amount of money(currency) in circulation and the available gold supply. In order to speculate where the price may lie it is important to examine all the possible influences.
Demand and supply are the primary determinants of price. Surprisingly to some the biggest driver of demand for gold is jewelry with India at the front of the queue. Approximately 500 tonnes of the yellow metal are purchased by India on an annual basis, as there are strong cultural and religious traditions attached to this buying, demand is fairly inelastic.
The next part of the demand side of the equation is investment. Over the last few years there has been a significant change here with Central banks becoming net buyers of gold in 2009. This coupled with increased purchases from an emerging middle class in China is adding more buying pressure, Indeed China itself as a nation have been aggressively accumulating gold over the last few years, no doubt due to its aspiration to usurp the American dollar with the yuan on the reserve currency throne.
The remaining side of demand is made up of industrial demand which accounts for 10% (electronics, dentistry etc).
The supply of gold comes mostly from mining (around 60%) with most of the remainder from recycling. In fact a decade of rising prices has spawned a 'we buy your gold' industry encouraging the public to part with their gold 'while prices are so high'.
You would think that supply and demand are the two obvious determinants of price, with gold this is only part of the story.Gold is an asset of finite supply whereas the unit it is valued in (US Dollars) is not. The supply of these US Dollars has increased progressively over the last 40 years since America came off the gold standard. In fact the last few years has seen unprecedented growth of the US money supply as the US Federal Reserve has sought to increase liquidity and combat what it sees as deflationary forces as debt deleveraging takes place in the system.
Influences on demand are expectations of future inflation or deflation and financial stability or peril.Also perhaps more controversially, control and downward manipulation by governments through a variety of methods as they have a vested interest in keeping the lid on the price of gold, which naturally competes with paper money and significantly should act as an alarm signalling trouble in the financial system. An organisation called GATA has long campaigned against what is sees as government intervention in the gold market.
Under a gold standard the price of gold is determined by dividing a proportion of the money in circulation (fixed) by the weight of gold held in the central bank's vault. Historically there have been different ratios used from 20% to 100% of the money supply against bullion in the vault. If gold advocates are to believed then using the conservative 20% metric, the true price of gold would be around $8,000 dollars - far higher than the $1590 at the time of writing.
If you believe that all markets eventually find their true price discovery and that the gold price will ultimately reflect the amount of currency out there, then the present day price could be described as being at base camp of Everest, with the summit well above 8,000.
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