What Will Happen to the Price of Gold With a World Credit Contraction?
Original post by Ciaran John of Demand Media
The price of any commodity, such as gold, can fluctuate over the course of time due to a number of different factors that include supply and demand. Commodity prices are particularly volatile during times of recession, and if a recession leads to a global credit crunch then commodity prices can rise rapidly. However, these price increases are sometimes short lived.
During recessions, large numbers of consumers and businesses run short of cash and default on loans. Banks can become insolvent when significant numbers of borrowers default on their debts. To mitigate against the risk of insolvency, banks curtail lending and economists refer to this situation as a credit crunch. A credit crunch can spread from one nation across the entire world because national governments and corporations raise money by selling debt securities on different stock markets around the world. If investors in one county lack the cash to buy securities from another county, then the recession quickly spreads and a credit crunch can follow.
Investors view gold as a safe haven investment because it has been traded as a valuable commodity for thousands of years. While gold prices tend to rise over the course of time, gold does not appreciate in value as fast as stocks or other kinds of securities during a market boom. However, during a global credit crunch, corporations around the world become insolvent because these firms can no longer borrow the necessary funds to cover short-term costs. Investors who fear losing their principal tend to sell their stocks and invest in safer investments, such as gold. As more investors buy gold, the price rises.
During a global credit crunch, investors all over the world end up competing to buy gold. Because the world only has a limited supply of this commodity, the price can sky rocket very quickly. However, at a certain point the credit crunch that caused the spike in gold prices actually causes the price to fall. The credit crunch prevents investors from borrowing funds to buy gold. As gold becomes more expensive, fewer people can afford to buy it and eventually the supply of high-priced gold outstrips the demand. When this happens, the people who hold the gold cannot sell it without lowering the price, so the price starts to fall again.
When you buy during a global credit crunch, or during an economic boom time, you can expose yourself to a variety of risks. In a credit crunch, rapid price movements can create a price bubble, which means that inflated price gains are followed by a sudden price drop. During an economic boom, increases in the value of gold may lag behind inflation. This causes you to lose spending power because if you sell your gold today you can buy less with the proceeds than if you sold your gold for the same price a year ago. Therefore, gold as a commodity has its pros and cons, and people make money and lose money with gold during all types of economic conditions.
- "Time"; Is Gold Really the Safest Investment?; Ari J Officer; March 2009
- American Enterprise Institute for Public Policy Research; John H Makin; March 2003
- "New York Times"; U.S. Recession Could Slow Gold's Rally; Veronica Brown; January 2008
About the Author
Ciaran John began writing in 1994 with contributions to "The Hourly Press" and "The Sawbridgeworth Observer." He holds a Florida Life, Health and Variable Annuity license as well as series 6 and 63 securities licenses. He has a Bachelor of Arts in theology from Kings College in London.