Understanding the Price of Gold

On July 19th, 2013, Ben Bernanke said during the Senate Banking Committee hearing, “Nobody understands gold prices and I don’t pretend to either.” This generalization has caused a bit of backlash from financial experts, and raises the question whether anyone can really understand the price of gold? Let’s take a look.

Experts agree that the price of gold typically ties closely with the supply of money. In other words, gold follows global liquidity; when gold supply doesn’t change, but more money is chasing the gold, the gold price goes up. Said another way: supply and demand drive the gold price. It’s not exactly rocket science, but it does help even casual investors begin to understand gold’s price.

Gold has seen some growth in recent weeks, following the most recent bottom of $1179 an ounce on June 28, 2013. As of July 22, gold had increased 12.5%, or about $150 an ounce, in a little less than a month. Much talk has been made this year about gold’s decline, and what it means for investors and for the future of gold.

But, look at the bigger picture. $1179 in June may seem low, but compared to 2008, when gold was trading for around $800 an ounce, and suddenly the $1179 number is not so bad.

Let’s take a look at the price of gold from an even bigger perspective. At the Museum of London, a Roman coin is on display that contains 8 grams of 22 carat (90%) gold. The exhibit indicates that the coin was enough currency to purchase 400 liters of cheap wine about 2,000 years ago.

Today, one gram of 22 carat gold equals about 44 euros. Therefore, 8 grams (the amount in the coin), equals about 350 euros. You can buy cheap wine in Europe for around 1 euro per liter, so 350 euros can buy about 350 liters of cheap wine. Thus, you can conclude that gold has held its value quite well over the past 2,000 years. In fact, based on this example, it is undervalued.

What Bernanke may have meant when he said he didn’t understand the price of gold was that he couldn’t predict the future of the price of gold. If so, he is right; no one can. But, if you look at the factors that affect the price of gold, as well as the history of gold’s significance and value across thousands of years, it is safe to say that buying gold online as a long term investment is a good idea.