Impact of Gold on World Economy

Topics: Inflation, Gold, Gold as an investment Pages: 14 (3999 words) Published: November 23, 2010
[pic] Introduction

There is very little, if any, effect on the economy from the price of gold. If anything, the opposite is usually true: perceptions about the economy can directly affect the price of gold. The usefulness of gold as an economic indicator is questioned by some, but it is still widely recognized as a hedge against the U.S. dollar and as some measure of inflation. Gold is used in most electronic devices such as computers and cell phones, but in such small quantities that fluctuations in the price of gold have very little impact on this sector of the economy. Gold and Inflation

Traditionally, the price of gold was seen to reflect monetary inflation, that is, inflation of the money supply. Because the fractional reserves banking system under the Federal Reserve is inherently inflationary, the total amount of money in circulation tends to expand, at times rather sharply. If monetary inflation exceeds real growth in products and services, then the result will be price inflation, which is what is measured by government measures of inflation such as the Consumer Price Index (CPI) and Producer Price Index (PPI). The balance of supply and demand for gold tends to change relatively little from year to year, so, for decades; changes in the price were attributed to inflation. Because rising inflation often coincides with a booming economy, a rise in the gold price is sometimes coincident with a strong economy.

Gold and the Dollar
In a sense, the value of the dollar reflects the health of the US economy. However, in a floating currency system where the dollar is only priced relative to other floating currencies, it is increasingly difficult to use currency movements as a measure of the economy. Still, gold is a very popular hedge for large institutions against devaluation in the US dollar. As the value of the dollar goes down relative to other major currencies, the price of gold tends to move higher, though the correlation is not always perfect. The movements in the dollar, however, can be more much attributable to changes in other national economies than in the US itself. When the dollar is seen to be on the rise, investors tend to flee from gold, causing the price to drop rather precipitously, without necessarily signaling a slowing of inflation. Gold and Mining

The only real direct effect gold has on the economy is in the mining sector, where individual companies may be highly sensitive to any fluctuation. Because gold miners make their profit from selling gold, their profit margins are largely determined by the prevailing market value of the commodity. In past decades, miners hedged their production in the futures market to create some stability and transparency, but that practice largely ended in the first decade of the twenty-first decade as the volatility of gold and its rising price made it unprofitable to do so.


This chart from the World Gold Council shows, global gold mining production has actually declined since 2000, despite the huge run-up in Gold prices.

Now China leads the world in gold mining output, having upped its production in 2007 by 12% over 2006, producing 9.7 million ounces or 276 metric tons, according to GFMS.

Gold options are option contracts in which the underlying asset is a gold futures contract. The holder of a gold option possesses the right (but not the obligation) to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying gold futures at the strike price. This right will cease to exist when the option expire after market close on expiration date.

Call and Put Options

Options are divided into two classes - calls and puts. Gold call options are purchased by traders who are bullish about gold prices. Traders who believe that gold prices will fall can buy gold put options instead. Buying calls or puts is not the only way to trade options. Option selling is a...
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