What is the Price of Gold

    Prior to 1970, the US Government set the price of gold, so that an ounce of gold represented a certain fixed number of dollars. Until that time other countries set their currencies as being convertible into dollars at a fixed exchange rate, and thus the price of gold in those foreign currencies was also constant, until they devalued against the dollar. The dollar was itself devalued against gold from time to time by government edict. That was known as the gold standard. Since 1970, the price of gold has been allowed to float freely.
    (The chart on the left shows both the growth and some of the fluctuation of the price of gold over the last decades.)

    The usual benchmark for the price of gold is known as the London Fixing. This is done at a twice-daily meeting of a committee consisting of five representatives from bullion-trading firms. In addition to the gold fix, there is active gold trading based on intra-day spot price. These are derived from multiple gold-trading markets around the world as they open and close throughout the day.

    Today, like all investments, and commodities, the price of gold is ultimately driven by supply and demand, including hoarding and dis-hoarding. Unlike most other commodities, the hoarding and dis-hoarding plays a much bigger role in affecting the price, since almost all the gold ever mined still exists and is potentially able to come on to the market at the right price. If, for example, the gold price were $100,000 an ounce, queues would form outside bullion dealers as people tried to sell their wedding rings. About one fifth of all gold ever produced sits in official gold reserves at various central banks, to be used only in a last resort in case of a national crisis. Given the huge quantity of above ground hoarded gold, compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production or gold jewelry demand.

    The IMF and central banks play an important role in the gold price. European central banks, such as the Bank of England and Swiss National Bank, have been selling a total of approximately 500 tones of gold a year from the late 1990's until 2005. However, with inflation creeping back into the system, some say the tide may be turning. In November 2005, Russia, Argentina and South Africa expressed interest in increasing their gold holdings. Other than Russia, these are not viewed, as significant central banks, but any move by Japan, China or South Korea to do the same would be seen as significant. Currently the USA has 75% of its foreign reserves in gold, whereas China holds approximately 1% in gold.

    Although central banks do not generally announce gold purchases in advance, some such as Russia have expressed interest in growing their gold reserves again as of late 2005. In early 2006, China, who only holds 1.2% of its reserves in gold, announced that it was looking for ways to improve the returns on its official reserves. Many bulls took this as a thinly veiled signal that gold would play a larger role in China's reserves, which they hope will push up the price of gold. It would however be impossible for China to increase its gold reserves by anything other than a small percentage, since there is simply insufficient gold available in the market.



    Gold US$/oz