Ask a hobbyist investor what they know about gold, and you're like to hear some variation of the words, "It's safe." Gold has become a refuge for investors during times of economic crisis. Investors who are adverse to risk often place their money in gold when they are worried about a looming financial meltdown or inflation.
Because historically, gold prices have been tied to economic slowdowns and troubled markets, gold values on the commodities market can be used as indicators for fundamental analysis; however, as with all types of indicators, it is important to remember that it's always possible for the markets to perform in an unexpected way and break out of historic patterns.
How gold performs during times of economic strife depends on a variety of factors, including:
- How great the financial crisis is
- What specifically caused the crisis
- Where the crisis is centered
- How long the crisis will likely last
As an example, during a minor, short-term economic slowdown, the price of gold is likely to climb. Let's say, though, that the crisis becomes very severe and widespread. People need to begin selling off assets in order to have necessary working capital. As a result, they begin liquidating their gold. The influx of gold into the commodities market would cause the price to plummet even though the world has not gotten anywhere near recovering from the financial turmoil. Let's take a look at how gold values historically relate to different economic conditions and factors, bearing in mind that these are just patterns and not meant to be concrete rules.
1. Inflation and Deflation.
When central banks decide to raise interest rates, prices on gold usually rise as people begin to fear economic slowdowns and shift their money to the "safer" investment. Conversely, when central banks slash rates, gold prices may fall as investors begin to sell off gold to pursue other investment opportunities.
2. Indian Economic Conditions. India has a very large population and gold is highly prized there. During times of prosperity in India, the demand for gold often rises, leasing to increases in price. When India's economy slumps, the price of gold may fall accordingly.
3. The Australian Dollar.
Australia is one the world's leading exporters of gold. Whenever the value of gold rises, the value of the Australian dollar tends to rise as well. Similarly, when the global demand for gold shrinks and the prices fall, the Australian dollar will usually diminish in value due to the importance of gold exporting on the economy.
4. The Swiss Franc. The Swiss Franc is partially backed by gold. When the value of gold increases, so does the value of the Swiss Franc in most cases. As gold prices fall, the Swiss Franc's value will typically fall as well. In addition, Switzerland has long had a tradition of remaining neutral during times of international conflict and has a trusted, strong financial system. During times of economic slowdown when the value of gold rises, the Swiss franc is often viewed as a more secure form of currency than others, driving its price up even more.
5. The US Dollar.
The price of the US dollar is usually inversely related to gold prices. When gold prices rise, the value of the dollar is usually on the decline. That's because the dollar is the world's most traded currency, so when investors are scared into buying gold it is often at the expense of the dollar. The US dollar has a number of other relationships that will be covered at length in the final section of our piece on fundamental analysis.
Keep in mind that no aspect of fundamental analysis is meant to be viewed in isolation. That's what separates a true fundamental analysis from other types of analysis. To properly use fundamental analysis, you will examine a number of factors, including information about economic growth and slowdown, the status of the Chinese economy, the value of gold, the value of the American dollar and world news and financial information. A well-rounded approach to financial analysis will produce the best results with trading.
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