In the overall world economy, the performance of the gold market can be one of the greatest concerns, particularly as gold has relatively steady intrinsic value. This January witnessed a bullish gold market, however, this was followed by a decreasing gold price in the last few days. Is this downward trend going to continue or is it just a fluctuation caused by a large number of short positions in gold? The relevant economic factors should be examined in order to predict the future price trend.
Increased Global Debt
Global debt has increased to a high level that may be perceived by some as potentially leading to financial instability. The growth of GDP has fallen behind the growth in debt, posing insolvency problems for countries such as Greece, Japan, and China. In order to service their foreign debts, governments may borrow, seek for bail-out plans or sell foreign exchange reserves which include gold. When governments decide to sell gold, gold supply rises but the magnitude of this increase is limited by the Central Bank Gold Agreements. Additionally, governments may use other ways to finance debts instead of selling gold as selling gold may incur capital loss. For example, with increasing but not too heavy debts, the Chinese government is able to finance its debts by issuing government bonds and using its holdings of large amount of foreign currencies. Meanwhile, potential financial instability encourages people to hold more gold to avoid large risks. More gold demand by individuals means higher future gold price. The effect is more likely to take place in the long run as economies may not be instable if the debts are going to mature in the far future.
Deteriorating Global Economy
The economies of Europe is growing very slowly and is struggling with deflation, which has become somewhat worse this January, while the Asian economies are also growing slowly. The previous slump in oil price deepened the deflation in the Euro zone further while posing serious problems to Russia’s economy, which is currently grappling with high inflation. In order to boost the economy, the ECB launched a quantitative easing programme recently with a very low interest rate. At the same time, the US economy is now improving and the Federal Reserve exited the QE 3 Programme several months ago. The practice of a QE plan in Europe was then followed by a larger supply of euros and thus the dollar appreciated against the euro. According to the Interest Rate Parity, arbitragers may contribute to the depreciation of the dollar against the euro by lowering the interest rate in Europe. However arbitraging activities can influence the dollar price only in the very short run without making differences to the longer-term price. The stronger dollar leads to a lower price of gold as the gold in the international market is denominated in US dollar. It is noteworthy that the American economy was reported to slow down in the last quarter in 2014. Dollar is likely to become weaker later as doubts about the recovering US economy exist.
Stock Market Performance
Accompanied by the recovering oil price, the stock market has been bullish these last few days. The increasing FTSE 100 and Dow Jones Industrial Average reflected investors’ confidence in stock markets. Investors tend to diversify their portfolios away from the gold which has relatively low risk to risky stocks. Lack of demand for gold will trigger a decrease in its price.
Unlike fiat money, gold has intrinsic value that can be stored. The upcoming UK General Election results and the prospects of Greece leaving the Euro zone may influence the longer-term gold demand and hence its price.The gold price therefore is likely to decrease in the short term but increase in the long term. However, there are still many others factors that need to be taken into account such as the trading activities and people’s expectations for the gold price. Technical analysis can be executed to provide clearer guidance about the best timing of taking short or long positions in gold.
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