How the Price of Gold is Determined

Most investors may not be aware of the two main causes for the change in the gold (or all other commodity) price. It is not simply greater demand and less supply.

Again, gold has been making the news. For eleven consecutive weeks gold has closed higher. But, does this only mean the price (in US dollars) has gone up? Most investors may not be aware of the two main causes for the change in the gold (or all other commodity) price. It is not simply greater demand and less supply.

There are two factors to determine the value of gold – in and relative to US dollars.

* The strengthening/weakening dollar compared to other currencies

* The buying/selling of physical old (or gold contracts)

Gold is simply a shiny valuable good that has intrinsic value. As with any good one buys, the stronger the US dollar, the fewer one needs to purchase a good.� So, the weaker the US dollar, the more one needs to buy the same amount of said good. It is because of this principle that units have been standardized, i.e. ounce, barrel, etc.

With this, it is a very safe assumption to say that the change in the gold price is partially due to the change in the value of the US dollar. Mathematically, this fluctuation can account for as little as 0% to as much as 100% of the change in the gold price, both positively or negatively. Realistically, this will seldom account for the extreme 0%/100%.

Simply, when the dollar gets strong, the gold price goes down. When the dollar weakens, the gold price goes up.

For the actual buying and selling of gold, one must again look at the currency fluctuation, but ALL currencies, not just the US dollar. This would include the Euro, Pound Sterling, Yen, Yuan, Swiss Franc, Canadian Dollar, etc. If the price is higher in each of there currencies relative to their respective previous day’s values, then the price of gold has increased due to demand. Therefore it actually increased in real value. If the price is lower, then it decreased in real value.

With this, a hybrid analysis must be done, analyzing the price of gold in US dollars and other leading currencies. If gold is nominally less expensive in US dollars and more in other currencies, the price of gold had decreased because of a strengthening US dollar and vice versa. This has to be analyzed relative to the trading volume of gold. This may be done by analyzing the trades on the New York Mercantile Exchange and Commodity Exchange, Inc (COMEX) and the London Metals Exchange (LME).

So, taken into account that gold is a good, it is also a currency without a country so it must be monitored like a good (as an equity/commodity would) but also relative to other currencies.

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Comments

  • Dan B.

    April 15, 2013

    This does not tell me who or what determines the price from day to day or second by second. It still sounds that some guys in a smoke filled room decide. When the experts are not able to explain an abrupt rise or fall in gold prices then what or who is deciding what the price is?

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