I don’t really know if gold is the most important precious metal, but one thing is for sure: It’s the most popular of them all, and investors use it as a safe haven against inflation and in times of crisis.
Historic Background
The Encyclopedia of Economics and Liberty defines the gold standard as "a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold. National money and other forms of money (bank deposits and notes) were freely converted into gold at the fixed price."
We all know (or should know!) that in the past, most countries used the gold standard to give real value to currencies, as the amount of gold each central bank treasured was there to back all circulating bills printed by the monetary authority. This made sense. Money was real somehow. But on Aug. 15, 1971, U.S. President Richard Nixon ended all there was about the gold standard and all currencies in the world stopped having a commodity to back them up.
Nowadays printed money is worthless by itself and it has only the value of serving as means of exchange. Its real value is defined by market forces and depends on supply and demand.
Recent Gold Rush
During this last financial crisis, The Fed and other central banks began a rescue task for the economy, pumping billions of dollars into the system which was demanding it. But now we can see the economy was flooded by dollars, and all we could expect about the currency was to lose value as its supply had increased substantially.
When this happens, one of the first things people think of is gold! This metal has always been regarded as a valuable and reliable source of intrinsic wealth. So its demand rose at the same time dollar issuance grew. The result: Gold prices went up.
Economic Recovery
In present days, the economic crisis is increasingly considered to have been left behind. Almost everyone is expecting more growth in years to come, and this means more demand for the dollar. On the other hand, the Fed, which is the one who controls the supply side, is thinking of shrinking the dollar’s issuance in the near future. With these factors in mind, it is only fair to expect a decline in gold prices as demand momentum must likely wane.
Interest Rates
To help the economy recover, the Fed not only pumped a lot of money into it but also lowered the reference interest rate from 5% to 0% very quickly to help the system absorb the dollar flood. Currencies tend to lose value when interest rates are down, and get stronger when they go up. However, the rate that really matters to markets is the 10-year Treasury rate because it’s not fixed by a monetary authority and carries future expectations with it.
On the other hand, precious metals like gold follow the opposite behavior when we compare them with interest rates.
As you may see in this Yahoo Finance chart, I compared SPDR Gold Trust (GLD, Financial) which is an ETF that perfectly reflects the price of gold (highly recommended if you want to buy gold as a stock) and the 10-year Treasury interest rate (^TNX).
There’s an inverse correlation between both of them which we can see very clearly. Now that everyone is expecting the Fed to reduce its stimulus programs and start raising the reference interest rate in the following years, there’s only one way to go for gold: down.
I would not recommend having a long position in this metal if you are a medium/long-term investor as it has great chance of losing value in the near future.
