price of gold : What really controls the price of gold?

If you were to ask your average person the question: “what drives the price of gold up or down?” they would probably give you an answer that has been told to them for years: the value of the U.S. dollar entirely dictates the value of gold. This is often one of the biggest misconceptions in the modern, globalized economy. While it may have been true twenty years ago that the value of the U.S. dollar (primarily due to inflationary cycles) was the sole indicator of the value of gold, it is no longer the case.

Today, everyone has their own theories as to what controls the price of gold. If the economy worsens, then the price of gold should increase. If the economy improves, then the opposite should occur. If interest rates are low, then gold will rise. If interest rates are high, gold will fall.

You get the idea, right?

Clearly, these all cannot be true—at least not simultaneously. History has shown us many instances where our commonly-accepted economic rationales for the value of gold simply do not hold true. For instance, there have been many periods where the strength of the dollar has improved, yet the value of gold has increased as well. Likewise, such as in 1989, interest rates were high yet gold was as well. Moreover, certain concepts of supply and demand—the very backbone of economic theory—don’t apply either. At the end of 2009, when the IMF released nearly 400 metric tons of gold for sale, the price of gold continued to rise. Despite an increase in readily available supply for consumption, prices did not fall.

What gives, then? What is the correct answer?

If we use the old macroeconomic adage of “if everything else is held constant, then this theory is always true,” each theory could be correct at any particular moment in time. Unfortunately for theories, the real world is a different animal entirely. There are, quite literally, hundreds of factors which can dictate gold prices. In this globalized economic world, almost every commodity has its value based to some degree on the value of every other commodity, with particular emphasis given to complimentary commodities (i.e., gold and precious minerals such as diamonds). World crises, domestic economic crashes, foreign economic crashes, foreign credit market collapses, domestic credit market collapses—these all would lend one to believe that the value of gold would increase.

There are, however, daily indicators of the value of gold. In addition to the value of the U.S. Dollar, it’s important to look at the price of other commodities which are essentially large enough to be their own individual markets, such as petroleum. On the grand scheme of things, the largest factor driving the price of gold may be civil and foreign conflict, but to judge this on a day-to-day scale becomes impractical.

Ultimately, it comes down to one reality. Every nuance of the world economy affects the price of gold. The difference, of course, is that gold sometimes does not act like other commodities with respect to economic principles. But this is because it isn’t just another commodity.

Gold is money.